Is the hot Orange County commercial real estate market finally cooling a few degrees?
Pointing to a lack of developable land and higher interest rates, many real estate professionals have voiced the opinion that commercial construction is due to slow down from its hectic pace of the past few years. Based on a report by F.W. Dodge on future construction contracts in Orange County and anecdotal evidence from leasing brokers, those folks may be right.
The value of future Orange County building contracts awarded in March, the latest month for which figures are available, totaled $247.3 million, a 30% drop from the $351.7 million in contracts awarded during March 1999. Commercial construction activity may be in for the biggest hit, as the $68.9 million in future contracts awarded in March was a 45% fall-off from the $125.3 million awarded during March 1999. (On the residential side, the value of future contracts slipped 21% to $178.4 million.)
Builders and developers point to three main reasons for the expected slowdown: lack of buildable land, instability on Wall Street and increasing interest rates.
Brandon Birtcher, president of Birtcher Real Estate Group, said the figures aren’t all that surprising, considering the amount of land that was developed during this latest cycle.
“There is a diminishing supply of buildable commercial sites, especially in the more mature and urban areas of Orange County,” he said, pointing to Irvine, Santa Ana, Anaheim and Brea as examples. “There’s just a very small number of opportunities remaining. This particular cycle seemed to consume an enormous amount of land.”
Given that scenario, the competitive advantage has shifted decidedly to firms that already control buildable sites. Parker Properties, which is developing the 1.7-million-square-foot Summit Office Campus in Aliso Viejo, is one of those companies.
Russ Parker, president of the Parker Properties, said his firm is moving aggressively to develop the next phase of buildings at its office campus, an environment that has become a favored one among many corporations looking to relocate. In a little more than two years, Parker Properties has built 700,000 square feet of space at the Summit Office Campus.
“From the Summit’s standpoint, we have a lot that we’ve done and then we have a 300,000-square-foot phase that we plan to start in about a month,” Parker said.
Moreover, Parker Properties is sufficiently comfortable with the leasing environment that it will launch construction of the new phase on a speculative basis.
As for the F.W. Dodge figures on an expected slowdown, Parker said he was surprised, even more so since he recently took a flight over most of the competition’s ongoing construction and saw the flurry of activity.
Besides the lack of buildable land, Birtcher pointed to another reason for a potential slowdown: The wild gyrations of the stock market in the last month or so, especially in the high-tech and the biotech sectors.
“The capitalization of the biotech and high-tech industry has been slowed dramatically in the last several months by the fear of which direction the stock market is going to take in the longer term,” Birtcher said. “In Orange County, a measurable amount of our growth is coming from high-tech and bio firms.”
Russ Parker does not see that trend at his firm’s development. Indeed, while dot-com or other Internet-related ventures accounted for roughly 30% to 40% of the prospects for his company in 1999, he said that number is now closer to 50%. And while the credit requirements for these firms have increased since 1998, there’s been no significant adjustment since then to reflect the sector’s wild ride on Wall Street.
“Are we concerned and careful? Yeah, heck yeah,” Parker said. “But we’re getting 15 to 20 months down-time coverage in case their business does fail and can’t perform on their lease. We’re trying to give ourselves enough collateral to cover us on the down time.”
Additionally, while developers that cater to tech firms are customizing their buildings to meet the needs of these firms, they aren’t doing so to the point of making their buildings white elephants if this tech business goes away.
“Am I building a single-purpose, single-user building? Absolutely not,” Parker said. “But I think the high-tech people are here to stay.”
Finally, there’s what everyone is calling the Alan Greenspan factor. Determined to slow an economy he believes will become overheated, the Fed chairman has steadily increased the prime interest rate over the past 18 months. While this already has affected the building environment, many developers expect the rate hikes to continue for the foreseeable future.
“We’re expecting at least two more increases of at least a quarter of a point that will continue to play a role in the cost of developing spec product,” Brandon Birtcher said.
While future construction contracts have slowed down, the pace of leasing is also slowing.
Steve Jones, president of Snyder Langston, said he has noticed a slow down in the pace of leasing activity, especially in planned retail centers.
“The retail stuff we’re doing is having a real tough time getting leases done,” said Jones, whose Irvine-based construction firm regularly develops theater-anchored entertainment centers. “There’s a difference in the theater business, all the guys are having a tough time in that niche. Those have been the most recent favored anchors for deals. Now the question is, are they really going to be the anchors for new entertainment retail centers?”
As a result of the slower leasing pace, construction of new projects is slipping beyond the targeted start date, a trend Jones said he expects to continue.
George Economos, senior vice president in charge of office and investment properties with brokerage NAI/Capital Commercial, said he sees a slowdown, too.
“I would say it’s slowing only moderately and most people think it’s slowing faster than it is,” Economos said. “When you go out and look for space, it’s pretty tight.”
Like Birtcher, Economos pointed to instability in dot-com firms as one reason for the slowing pace. Another factor, he added, is that the pent-up demand from the recession has been satisfied.
“Underlying all of this is that business is pretty damn strong,” Economos said. “It’s like an Alan Greenspan thing here,everyone keeps waiting for the other shoe to drop, but everything keeps going pretty strong.”
