The Orange County market appears to be building strength as employment growth led companies to absorb more space in the third quarter than they had in the prior two.
Qualified workers are easily finding jobs. Local employers are benefiting from an expanding pool of skilled applicants. In August, employment was up by 17,100 jobs, or 1.1%, from a year earlier.
Professional and business services posted the largest growth, up by 6,900 jobs, with more than half of the increase in administrative and support services.
In real estate, the office vacancy rate dropped to 6.9% in the third quarter, down from 7.6% in the prior quarter and 12% a year earlier. OC is absorbing office space at a gradual and healthy pace. For the third quarter, net absorption totaled more than 500,000 square feet.
Where are the lowest vacancies? High-rise buildings.
Because of this, lease rates there have grown by 10% or more during the past three quarters. Rising high-rise rents have caused some tenants to move to low- and mid-rise buildings.
In the coming year, we can expect 4 million square feet of office space to come to the market.
The county has another 1.6 million square feet of planned projects and 8.2 million square feet in proposed projects.
Despite rising absorption and falling vacancies, there is evidence of a pending slowdown at least partly related to the housing and mortgage industries. Deals have slowed. And tenants can see buildings going up around them.
Consequently, they’re asking, “Would we be better off waiting till mid-2007 to renew?”
The good news is OC continues to be an attractive place to hire and retain a highly educated work force. It’s still seen by many as a bargain, compared to rents in San Diego or the Westside of Los Angeles.
Airport Area
The John Wayne Airport area ended the third quarter with a vacancy rate of 7.6%, down from the second quarter’s 8.4% and nearly 6 percentage points below last year’s 13.2%. This submarket led the county in absorption with 432,422 square feet.
Big leases in the airport area: Arbonne International LLC’s sublease of 89,420 square feet at 3 Park Plaza; W.B. Doner & Co’s lease of 36,377 square feet at 4675 MacArthur Court; and HDR Engineering Inc.’s lease of 26,680 at 3230 El Camino Real.
With the completion of 350,000 square feet at Impac Center in Irvine, space under construction checked in at just more than 2 million square feet.
South County
This ever-changing and relatively young submarket has a lot of first generation space while still accommodating development.
Construction continues to flourish, with more than 1.6 million square feet of space under going up.
Developments include Discovery Business Center in the Irvine Spectrum, expansion of the Summit Office Park in Aliso Viejo, Vantis in Aliso Viejo and Mammoth Professional Office Park in San Juan Capistrano.
All told, about 1.1 million square feet of the space under construction is due by the end of the first quarter.
In general, vacancy, absorption and lease rates in South County are consistent with the leveling course of the overall office market. South County vacancy tightened to 5.6% in the third quarter and posted yearly absorption of just more than 97,000 square feet.
South County leases included: The Capital Group Cos.’ lease of 98,898 square feet at 15261 to 15271 Laguna Canyon in the Irvine Spectrum, and Avnet Corp.’s lease of 19,426 square feet at 430 Exchange in Irvine.
Central County
Central County has seen healthy activity.
Asking rental rates for class A space keep climbing. It is hard to find nice, clean office configurations that don’t require large amounts of investment by landlords.
The rising costs of tenant improvements should keep rents on the rise, or, at a minimum, steady. As ever, the dollar just doesn’t buy as much as it used to.
This also has led to a trickle down effect on class B projects as those landlords closely watch the margin between the “A’s” and the “B’s”. The vacancy rate ended the third quarter at 7%, versus 8.2% in the prior quarter.
The availability rate in the Central County is 11.3% with sublease space still on the market totaling more then 550,000 square feet. Average asking rents for class A space increased 6 cents in the third quarter to $2.45 per square foot. Class B rents rose 2 cents to $1.92.
North County
As lease rates continue to rise elsewhere, the North County submarket is looking more attractive to price-conscious tenants. The average asking lease rate for class A space decreased 2 cents to $2.27 per square foot in the third quarter. Class B rents rose 4 cents to $1.95.
Now the office building rumble has made its way to Anaheim, with plans for a three-story, 62,500-square-foot building. The project could be the last for the area as finding developable land in Anaheim and neighboring cities is a challenge.
The only real development prospect nearby is at the Boeing Co.’s campus. Boeing is in early talks with Anaheim officials about leaving and redeveloping 1.7 million square feet of industrial and office space it owns in the city’s Canyon Business Park.
West County
West County average office vacancies continued to decline in the third quarter. The vacancy rate ended the quarter at 6.5%, versus 7.1% last quarter, and 15% a year ago.
Major tenants leasing space include BJ’s Restaurants Inc., Ford Motor Credit Co., Countrywide Financial Corp. and Global Technologies.
The activity led the average lease rate for class A space to rise 15 cents to $2.34 per square foot and class B space to increase 5 cents to $1.95.
Challenges, Opportunities
With absorption slowing and rents leveling, we should see lease activity in 2007 continue normally, with 1 million to 1.5 million square feet of absorption. Toward the end of 2007, more than 1.5 million square feet of high-rise office space comes online, with much of this space expected to be preleased by existing OC tenants.
This will leave large holes in older buildings and could create lively competition to fill space. Hence, rental rates should drop a bit throughout 2008 as vacated space is absorbed.
Forecast
The overall outlook for the next 12 to 18 months is positive, with a slight, possible negative note due to anticipated low vacancy levels. This is despite the construction and mortgage sublease space, and continued normalized absorption.
Employment growth could average as high as 2.4% per year though 2007, though some economists see it closer to 1%.
The services sector will create most of the jobs, principally in business and healthcare.
Looking ahead, preleasing of more than 3.7 million square feet of construction that is under way will be a good barometer of continued market health.
Meanwhile, construction should remain fairly constant throughout the year. Sustained economic success should support demand and help absorb space. But inflationary pressures and higher interest rates still are a risk, lending a measure of uncertainty to an otherwise booming marketplace.
Construction still is booming, up 83% in the third quarter from the second.
Considering an average of 65% of construction was absorbed each quarter of 2005, widespread class A development isn’t surprising.
What is surprising: size. Developers are building bigger. Rancho Cucamonga’s Empire Corporate Plaza, the area’s largest speculative development, will include 400,000 square feet. Riverside’s The Grove will include 356,208 square feet. And Murrieta’s Crossroads Corporate Center’s second phase stands to be 78,000 square feet.
One group driving this trend is Orange County businesses. Faced with high rents and limited space in their own backyard,and ample workers inland,OC companies will drive the office market’s growth in 2007.
Market Assessment
The inland office market posted the second lowest vacancy rate in the nation at mid-year as strong tenant demand continues to absorb construction.
With vacancies less than 10% for nine straight quarters and asking monthly rents up 7.9% for class A space up and 5.6% for class B space from a year earlier, developers have broken ground on projects across the Inland Empire.
Recent history reveals that new space is being absorbed. In the third quarter, 98% of absorption was at buildings completed since January.
In the South County submarket, where class A asking rates can exceed comparable OC space, developers are under way on phase two of Murrieta’s Crossroads Corporate Center. The second of four, the 78,000 square-foot building follows its first phase success, leased to tenants including University of Phoenix and Wells Fargo & Co.
Predicting future vacancy averages with more speculative construction is tricky. In Rancho Cucamonga, IDS Real Estate has begun the largest speculative class A office project in the Inland Empire’s history. Empire Corporate Plaza, planned for two phases, includes 400,000 square feet. Three, two-story buildings are under way. Each is 84,600 square feet.
Marketed as an ideal corporate headquarters, city officials have received inquiries about the project: one from a local tenant and one from an OC business. Asking rent is $2.25 per square foot.
New space remains a bargain compared to OC. The Irvine Company is asking $3.60 per square foot for its least expensive space at Newport Center. It’s looking to charge a similar rate at twin office towers going up in the Irvine Spectrum. Yet the average rent for OC class A space is $2.71.
The Irvine Co., OC’s dominant landlord, is clearly bullish. Will prospective tenants be willing to pay its rates?
Opportunities, Challenges
If 2004 validated a demand for small buildings for sale, and the past two years saw condominiums targeting professional firms, then 2007 will be the year of medical condominiums. Omni West Group Partners with HG Capital LLC plans to build Moreno Valley Medical Center, consisting of two 40,000-square-foot buildings. Omni West also is working on medical condos in Chino and Lake Elsinore. Elsewhere, Aardex Corp. is building a seven-building condo campus in Moreno Valley and has sold about 80% of the space.
In sum: no discernable end to strong tenant demand and impressive increases in occupancies and rents
2006 is slightly ahead of last year’s record performance in two of the three most important measures. Net absorption is ahead, though rent growth is 3 percentage points behind through the first three quarters of this year from a year earlier.
Still, a 10.5% yearly gain in rents to $3.17 per square foot for class A and $2.29 per square foot for class B is healthy. The third quarter also saw vacancy decline by 70 basis points to 14.1% and net absorption increase by more than 383,000 square feet.
All this good news has changed market dynamics, beyond just higher rent costs. Landlords now favor shorter leases and fewer extension options, anticipating higher rents.
Lease renewals are becoming more common due to high costs of tenant improvement and relocation. Landlords aren’t as eager to offer incentives to retain tenants. Tenants face other challenges as well, including even more supply shrinkage.
Leasing activity is strong, and the deal pipeline is stocked with several large transactions, marking a bright future for San Francisco. Job growth is positive, and both existing tenants and those new to the area are chasing the local talent pool and making substantial commitments to the city.
Market Assessment
Strong market fundamentals pushed vacancy down by 10 percentage points since its mid-2003 peak to 14.1%, its lowest reading in five years. So far in 2006, leasing activity is at 4.7 million square feet, meaning almost 1.2 million square feet of positive net absorption and a 2.6 percentage point drop in vacancy. Still, high tenant improvement costs and relocation expenses certainly are playing a role in tenants staying put. The area south of Market Street is benefiting from the tech sector resurgence. It’s been one of the best performing areas in the city. Since 2004, over 310 technology companies have committed to some 3.5 million square feet of space.
Bottom line: healthy levels of activity have consistently pushed rents up and vacancies down. So far in 2006, city rents have climbed 10.5% from a year earlier. The North Financial District has the highest class A rent at $3.50 per square foot.
Opportunities, Challenges
What may be beneficial for landlords poses a challenge for tenants.
With tenant improvement and relocation costs rising, staying in place may prove more viable for companies than moving. Consequently, tenants may have to make do with what is available in their current location.
And while attractive rental rates still are available to tenants in some areas, it is becoming increasingly difficult for tenants to secure long-term commitments, especially on smaller deals. Landlords, on the other hand, rightly are banking on higher rents.
