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Thursday, Mar 28, 2024

Tenants Hedge With Short Leases, Subleases

The pandemic may have slammed real estate in the second quarter, but it was in third quarter when the coronavirus’ economic impact truly unfolded, as industry observers paint a picture of companies afraid to commit to long-term leases in the face of multiple uncertainties: the virus, a presidential election and evolving experiments in workforce dynamics.Most deals completed in the third quarter were started and completed since the onset of the pandemic.“This is the new normal,” said Michael Soto, Southern California research director for downtown L.A. based tenant representation firm Savills. A Savills study found the sharpest rise in subleasing since the Great Recession occurred in the third quarter. Leasing activity took an 18 percent hit across Los Angeles and while unemployment rates have dropped 4 percent to 16.1 percent as of August, Savills predicts a long, slow recovery for office.“Subleases are on the rise and they’re still continuing,” confirmed Colliers International Senior Executive Vice President Kevin Fenenbock, who is based in Santa Clarita but also handles San Fernando Valley deals. “It’s not necessarily companies going out of business but looking for (alternative revenue). In other cases, we’re seeing businesses saying that working from home is working.”According to Colliers International data, vacancy has ballooned to 12.6 percent in the San Fernando Valley compared to 11.8 percent in the second quarter. The central San Fernando Valley has been hit especially hard, with 14.6 percent vacancy — exceeding L.A. County’s 14.4 percent. Valley tenants vacated 275,700 square feet of space during the third quarter, more than quadrupling the second quarter’s loss of 56,400 square feet.Trend reversalBefore the virus, priced-out L.A. companies moved toward Warner Center and Calabasas.“That migration has stopped,” Fenenbock said.As a result, submarkets such as Sherman Oaks and Encino have been very aggressive on rental rates to retain tenants.“There’s still a lot of uncertainty,” Fenenbock said. “I’m on the phone daily with tenants going, ‘Gee, I don’t know what next year is going to look like.’”Short leases — six months to a year — have proliferated. Property owner creativity with tenant arrangement has become unprecedented.“Landlords have obligations, they’re having to navigate this,” he said.Trends that real estate pushed hard last year seem to have been curtailed by the pandemic. Coworking went moribund. The notion of young adults and their employers fueling a boom in places such as Warner Center froze.“We haven’t seen that translate yet,” Fenenbock said of live/work/play and more tech companies descending on Warner Center. “I’ve heard a lot of conversations about it, but I have not seen it yet.”Instead, he sees young adults moving to suburbs in Calabasas, Santa Clarita and Palmdale.The virus has chilled interest in traditional office buildings.“They don’t want to go through an elevator (or staircase), they want direct entry,” Fenenbock said, (But) “I don’t expect that is going to be long-lived.”Burbank strongIn the third quarter, Burbank saw the biggest leasing deal of the year when Netflix Inc. took 171,000 square feet to establish its animation studio.“Only Burbank is doing well,” Savills’ Soto said. “With Burbank, it’s always been a market that has been anchored by two of the biggest companies on the planet” with WarnerMedia’s Warner Bros and Walt Disney Co., plus Universal Studios in nearby Universal City. “Those major entertainment companies that are up there have really attracted Netflix.”Indeed, Colliers data shows Burbank is hovering at 6.2 percent vacancy, even lower than 10.6 percent this time last year.Beyond the Netflix deal at 2300 W. Empire Ave. in Burbank, LegalZoom grew its footprint by 49,000 square feet at 101 N. Brand Ave. in Glendale.

As for the future, Fenenbock spots rays of optimism in the office sector.“Most landlords believe that we’re going to come out of this,” Fenenbock said. “It isn’t as bad as retail.”For now, office tenants are putting off commitments by signing short leases.“Those companies are in cost-cutting mode and there’s an escalation of subleases,” Soto said, citing LegalZoom’s 18 months at 101 N. Brand Ave. “Tenants are increasingly asking for that level of flexibility during the COVID.”Fenenbock expects more of the same through year’s end.“I’m not expecting a huge velocity of deals,” he said.Soto agreed: “Usually, Q4 is when you see a spike in deals. I don’t know if there’s going to be a spike in deal volumes. Most companies are still in a wait-and-see approach.”   

Michael Aushenker
Michael Aushenker
A graduate of Cornell University, Michael covers commercial real estate for the San Fernando Valley Business Journal. Prior to the Business Journal, Michael covered the community and entertainment beats as a staff writer for various newspapers, including the Jewish Journal of Greater Los Angeles, The Palisadian-Post, The Argonaut and Acorn Newspapers. He has also freelanced for the Santa Barbara Independent, VC Reporter, Malibu Times and Los Feliz Ledger.

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