Jitters about Orange County’s office market are increasing after a third quarter that saw mixed, if not downright conflicting, results.
A survey of just-released data from local real estate brokerages showed the county’s vacancy rate rising close to 11% at the end of the third quarter. That’s up 50% from a year ago, and almost 20% higher than vacancy rates in the second quarter.
The buildings with the most empty offices are in Irvine around John Wayne Airport, which now run about 13% vacant. That’s up nearly 60% from a year earlier.
Many local brokers think that percentage is a point or two low.
Empty buildings are just one issue for local landlords. Leasing remained slow throughout the summer, and there was negative absorption of roughly 800,000 square feet in the last quarter, according to data from CB Richard Ellis Group Inc.
It’s a step backward for OC’s office market, which had been touted as one of the strongest in the country the past few years. And it comes when nearly 100 floors of empty office space is coming onto the market.
“The picture is pretty clear. The market is soft right now, especially for the class A office towers,” said Randall Parker, managing director for the Newport Beach office of Travers Realty Corp.
That gives tenants the upper hand in negotiations. Once vacancy rates approach 10%, market conditions begin to swing from being pro-landlord to a tenant’s market, most industry watchers say.
The reasons for the poor third quarter are numerous, including an oversupply of space, slow economy, the mortgage industry meltdown and marginal job growth, according to officials with Grubb & Ellis Co.’s Newport Beach office.
OC is “weathering through the subprime meltdown,” said Anthony Tran, Grubb & Ellis research analyst, in his quarterly report. “However, the impact has led to increased availability and vacancy levels.”
Other areas haven’t been as hard hit as Irvine’s airport area, which is seeing the majority of the county’s office tower construction. North and Western Orange County remain the tightest markets, with vacancy rates from 6% to 8%.
The higher vacancy rates didn’t catch area landlords by surprise. Much of the increase was expected after Irvine-based New Century Financial Corp. filed for bankruptcy and the Orange-based parent of Ameriquest Mortgage Co. began shedding excess space earlier this year, said Barry Katz, managing director of CB Richard Ellis’ asset services group in OC.
“Statistically, most of that (space) hit in the third quarter. I don’t see another 800,000 square feet being put on the market,” Katz said. “The question is: When do we start to go positive (on absorption) again.”
Grubb & Ellis predicts vacancy rates will reach 14% by the end of the year, up from 11.5% now.
“The last time it reached that level was in 2001 after the implosion of the dot-com industry,” Tran said.
And it took nearly three years for the market to rebound from those losses, he said.
While vacancy rates are up and leasing is slow, landlords continue to ask for record-high rates, the latest broker reports show.
According to CB Richard Ellis, the county’s average monthly asking rate for office space now is $2.77 per square foot per month, up 4 cents from the second quarter, and a 16% rise from a year ago.
For the best office space in the county, the average asking monthly rate now runs about $3.13 per square foot, according to Grubb & Ellis. That’s up 2 cents from the second quarter, and a 10% increase from a year ago. Near the airport, those rates are closer to $3.27 per square foot.
Brokers who represent tenants argue the market is worse than the numbers suggest.
“The market is not as robust as the numbers would indicate,” Travers Realty’s Parker said. “The market is in flux. Landlords are willing to negotiate more than they ever have before.”
There’s a growing discrepancy between what rents landlords are asking for at their buildings, and what tenants are ultimately paying, said Royce Sharf, branch manager for the Irvine office of brokerage Studley Inc.
“Asking rates are equal to the sticker price you see at a car dealership,” leaving plenty of room for negotiation, Sharf said.
“Concessions started showing up two quarters ago, when (landlords) started sweetening deals with free rent, and excess (tenant improvements). Now it’s concessions, and (lower) rental rates,” he said.
The asking price that data brokerages are reporting are likely being skewed somewhat due to the overall lack of leasing activity in the county, Katz said. A fewer high-end office leases could knock the average price up if there aren’t other older building deals to even it out.
It’s similar to what OC’s housing market is seeing, as the county’s median sales price continues to rise despite record-low sales.
More than anything, office market watchers said they will be keeping a close eye on job data for the next few quarters, to see when or if short-term conditions improve.
“I think the rest of the year is going to be driven by the employment figures. It seems as if the mortgage fallout is over, and the picture there is pretty clear. But if employment growth slows, then this could be a prolonged event,” Parker said.
The unemployment rate in OC was 4.2% in August, up from 4.1% in July and 3.6% a year earlier.
Another potential pitfall: If over-extended landlords who bought their way into the market default on their buildings, like many homeowners are doing, or unload them in quick sales to avoid foreclosure.
It’s not a likely scenario.
“Most of the landlords here are well-capitalized. It’s a good group,” Katz said. “We don’t expect to see many (commercial) defaults.”
If a few smaller office owners defaulted on their properties, there would be plenty of potential owners looking to buy out those properties, he said.
“It’s a choppy time right now. But we see a light at the end of the tunnel,” Katz said.
