Silicon Valley office landlords are still wincing from the sweeping technology bust that emptied their buildings in 2001 and 2002 as quickly as the technology boom absorbed space during the late 1990s.

Despite their wariness of tech tenants, Southern California landlords think the tech sector will spark another leasing rebound — this time on their own turf.

A 2004 Casden Real Estate Economics Forecast published by the University of Southern California concludes that the downfall of the Orange County office market in 2001 and 2002 was its reliance on telecommunications, high tech and business services. But it has proven to be less of a liability in 2003, and will become an asset in 2004 and 2005, according to the study.

“We will be the technology leaders for years to come, not just in California but in the United States as a whole,” says Victor Coleman, president of Arden Realty, a Los Angeles-based real estate investment trust with 18.8 million sq. ft. of office space in Southern California.

Coleman has “aggressive expectations” for tech-related leasing activity in the Los Angeles-area market. “In our portfolio, technology is one of the top five areas where we are seeing demand.”

A Reality Check

However, Coleman's enthusiasm is tempered by the hit Southern California office buildings took during the tech meltdown. Coleman singles out Santa Monica, West Los Angeles and Orange County — which had the highest concentrations of Internet and tech businesses — as three victims of the downturn.

“There is reason to believe that the technology market will be a demand driver here,” says Jim Costello, senior economist at Torto Wheaton Research. He believes technology is far more likely to drive the national economy than many other industries, and California is a tech hub. Still, Costello projects that the San Francisco and San Jose markets will lag the national office recovery in 2004.

Slow Recovery Ahead?

Chris Redfearn, a professor at the School of Planning, Policy and Development at the University of Southern California in Los Angeles, says the Bay Area's dependence on a single industry was the cause of both the sudden downfall and its likely slow recovery.

“San Francisco is a much smaller place than Los Angeles, and much more heavily dominated by a single industry,” he says. “It was like steel in Pittsburgh. Wherever you have a concentration of a single industry, real estate markets are much more vulnerable.”

Los Angeles, by contrast, is “a much larger and more diversified economy,” says Redfearn. Although certain submarkets like Santa Monica and West Los Angeles were singed by the Internet flameout, office leasing throughout the region has remained stable, though lackluster.

Redfearn equates the Bay Area's current predicament to Los Angeles back in the early 1990s immediately following cutbacks in defense spending. These cuts stymied Los Angeles' local economy for several years.

“There are many parallels,” he says. “We saw a net loss of population in the Los Angeles area, just as many people are moving out of the Bay Area nowadays. We will see this much slower recovery until all the space is absorbed.”

Outsourcing Is an Obstacle

One roadblock to strong positive absorption is the movement of technology jobs overseas. Research firm Gartner Inc. reports that outsourcing a typical corporate software project to India could save as much as 40% on labor costs. In addition, Forrester Research estimates that over the next 12 years, 3.3 million U.S. jobs will be moved overseas — and a full 14% of those jobs will come from the computer services sector.

Silicon Valley's office vacancy rate registered 21.6% in the third quarter, or 130 basis points lower than the previous year, according to CB Richard Ellis. Meanwhile, the office vacancy rate in Orange County declined 2.2% over the same period to 14.4%.

Steven Seligman, vice president of acquisitions and sales at Marcus & Millichap, is cautiously optimistic about an office leasing recovery. “We will see a slow comeback in the technology industry,” he says, citing bullish projections from Larry Ellison, chair of Oracle and a leading employer in Silicon Valley.

“We have had a lot of vacant office and industrial space, and much of that will be vacant for some time to come,” Seligman adds. “But with a clear turnaround in the national economy, we are optimistic we will see a turnaround here in Silicon Valley.”