Office Sublease Space Pours Onto the Market
in Pricey LA Coastal City in Pandemic

Santa Monica Feels Downside of Longtime Expansions by Tech Companies

By Lou Hirsh
CoStar News
August 24, 2020 | 3:54 P.M

.
The amount of sublease space has surged to a record high in one of California's most expensive office markets as technology companies that once helped make the market so pricey scale back during the pandemic.

Santa Monica, California, a coastal Los Angeles County city nicknamed Silicon Beach for its high concentration of tech firms and investors, had more than 1 million square feet of office space available for subleasing as of Aug. 19, nearly 40% more than the prior record set in 2009, according to data from CoStar Group and area brokerage firms.

“It doesn’t mean that the market is going to crash, but rising subleasing is almost always a leading indicator of a softening in office demand and asking rents,” said Michael Soto, Southern California regional research director for brokerage firm Savills.
Santa Monica reflects a heightened experience of a larger trend occurring in major tech hubs as companies re-evaluate their office space needs during the coronavirus outbreak. The elevated levels in the city represent a confluence of high prices, dynamic tech companies, and a declining necessity to be near amenities that were once important recruiting tools.

Santa Monica for decades has been among the Los Angeles region’s tightest and priciest office markets, with single-digit vacancy rates and monthly asking rents in several locations topping $6 per square foot, and even more than $9 a square foot at prime properties. Those rates put the city in the realm of a small group of the most expensive California markets including some in Silicon Valley and San Francisco.
Tech and media companies ranging from startups to established giants including Google have clamored for space in Santa Monica over the years as they were increasingly drawn there by its beachside lifestyle and young, educated workers as well as deep-pocketed investors.
Those factors aren't helping Santa Monica and nearby communities at a time when people are working from home, instead encouraging space give-backs. CoStar data shows sublease space in Santa Monica is now 6.7% of all office inventory, while the city's overall vacancy rate has grown to almost 11%.

By comparison, San Francisco's available sublease space is about 4% of market inventory, according to CoStar.

Tech Firm Space
Tenants putting portions of their Santa Monica office space back on the market for sublease since the start of the pandemic include electric scooter rental provider Bird, which listed 72,000 square feet; consumer internet company Leaf Group, which listed 52,800 square feet; and automotive digital marketplace provider TrueCar, which listed 38,300 square feet.

Others subleasing smaller amounts include ride-hailing firm Uber Technologies, tech finance startup Tala and job placement firm ZipRecruiter.
The Savills researcher said Santa Monica also stands out now because two other L.A. office enclaves that are even more pricey on average, Beverly Hills and Century City, are currently seeing “nearly negligible” subleasing.

The tenant bases in those two pricier areas consist largely of more established traditional companies, such as law and financial services firms, which have weathered multiple economic cycles layoffs, and see less urgency to adjust their space needs right now.
Much of the Santa Monica office base, by contrast, consists of newer technology and media companies that expanded during better economic times and are now having to reduce their footprints because of pandemic-related business curtailments and corporate work-from-home policies that could stretch well into 2021.

Santa Monica had been prone to higher levels of sublease space than the region prior to the pandemic because of the concentration of tech companies, which often sublease space as they quickly outgrow offices faster than they expect. Prior to the mid-March business restrictions created by the pandemic, automotive information provider Edmunds put 195,000 square feet up for sublease, for example.
But what's happening now is unprecedented for the city.

“Occupancy costs are likely a factor that creates more urgency in offloading office space, but more than anything I think it speaks to the current weakness of L.A.’s tech and startup scene,” said Ryan Patap, director of market analytics for CoStar Group in Los Angeles.

Sublease Opportunities
Relative to all available office space, Patap noted that Santa Monica’s rate of subleasing is second in the L.A. region only to the adjacent coastal area that includes Marina del Rey and Venice. All three enclaves are part of the Silicon Beach area where subleasings have risen significantly since September 2019, well before the pandemic.

The sublease space available is 7.3% of the nearby Venice-Marina del Rey market. In contrast, that figure is less than 3% in other tech-media hubs such as Culver City, which is also home to major tech companies including Apple and Amazon.
“It’s clear Silicon Beach is being acutely impacted relative to other locations in Los Angeles,” Patap said, noting office rents have already begun to decline in Santa Monica.

The available space has helped to push the city's rental rate down almost 7/10ths of a percentage point to about $5.42 a square foot a month, and it is the Los Angeles region’s third most expensive office market based on average asking rent, according to CoStar.
Subleases are often offered at a discount to traditional direct leases and can create competition with landlords seeking to lease their other available spaces in their buildings. It can sometimes force landlords to lower asking rates or offer additional concessions to tenants.
Analysts told CoStar News the city, depending on how pandemic impacts play out in coming months, could be seeing a historically rare tilt toward tenant- rather than landlord-advantaged metrics.

Carl Muhlstein, international director in the Los Angeles office of brokerage JLL, said there are lingering questions about when companies can actually return to working in offices, and how much space they will need when work resumes.
“Tenants in these spaces, and also the sublease tenants, are just not making decisions at the moment,” Muhlstein said of the Santa Monica scene.

The sublease trend isn’t necessarily all bad news for landlords. Going forward, Muhlstein said, some companies subleasing may not want to continue the arrangement with tenants whose own financial futures are in doubt in the current economy.

Some of these sublease tenants may choose instead in the long run to deal directly with office landlords who are increasingly offering competitive and flexible arrangements that are comparable to what many companies are now getting from short-term subleases.
Muhlstein noted that the landlord’s long-term financial future is often going to be more certain than the tenant from which a company is subleasing space. The landlord also probably has more capital to directly provide future needed flexible expansion space, extra storage and other needed improvements to companies that are currently subleasing or considering it, he said.

Among the potential near-term upshots of the subleasing spike, said Soto, is that early-stage tech companies and other firms looking to establish their first presence in the Los Angeles market might see relatively low prices in Santa Monica, where they have been shut out for decades by higher costs.

“It might be the chance for a smaller company to get into a nice Class A space at a relatively cheap rate,” Soto said.