A year ago, Orange County office vacancy rates stood at just a little more than 7%, among the strongest markets in the country. With continued job growth projected, and few office projects near completion, many industry experts said it was possible that vacancy rates could drop to the 3% range within the next 12 months, prompting a surge in rents beyond even the double-digit increases seen as of late.
What a difference a year makes.
Due in large part to the continued woes of the subprime mortgage industry, which is heavily rooted in the county, OC’s office vacancy rate now stands at about 9%, according to Paul Rutter, executive vice president for Maguire Properties Inc.
Further cutbacks in the subprime industry, which takes up about 4% of the county’s office space, could soon drive vacancy rates here to about 11%, Rutter told analysts in a recent earnings call.
That’s still considered a healthy market, although when vacancy rates enter double-digit range, it’s hard to characterize it as a landlord’s market, industry watchers say.
More changes to the OC office market are set to take place in the next few months, when the first of several high-rise offices begin to open their doors.
Six high-rise towers, totaling more than 1 million square feet of space, are set to come to the market by year’s end, part of nearly 4 million square feet of office space being built in the county.
Houston-based Hines Interests LP should be the first to open its doors. It has scheduled a grand opening event at the end of the month for its 261,400-square-foot 2211 Michelson Ave. project next to John Wayne Airport.
Maguire should be next to finish, with its 530,000-square-foot 3161 Michelson tower a few blocks down the street.
The defining characteristic of the new towers so far: a lack of major tenants preleased.
In the past quarter, the combined size of all the deals signed fell far below the additional 190,000 square feet of preleased space Maguire now needs to remarket, following the bankruptcy of former anchor tenant, subprime lender New Century Financial Corp.
A few lease deals are beginning to be made. The past week has seen sizable deals announced for two of the towers being built (see story, page 1).
Maguire signed on law firm Greenberg Traurig LLP to take 38,207 square feet of space at 3161 Michelson.
Meanwhile, Opus West Corp. signed on the first tenants for its Opus Center Irvine III tower. Accounting firm Singer Lewak Greenbaum & Goldstein LLP is taking about 25,000 square feet. Opus also is planning to lease space for its own operations at the building.
There still are more than 20 businesses actively looking for one or more full floors of high-end office space in the area, and many of them are eyeing the new buildings going up, according to Jay Carnahan, managing principal of Costa Mesa’s Orion Property Partners Inc.
“Tenants see all this steel in the air, and think the market is going to soften,” Carnahan said.
Add to that the media coverage detailing the subprime industry’s problems, and there is a commonly-held perception that the office market will soon favor tenants, he said.
“But when it gets delivered, they’re going to find that the pricing dynamics are still moving up,” Carnahan said. “(Landlords) are not going to drop their rents.”
Don’t expect any of them to push the panic button, he said.
Developers such as The Irvine Company, Maguire and Hines are “the absolute best in the business,” as far as long-term office owners, he said.
Meanwhile, Opus West is one of the country’s top merchant builders,a company whose goal is to sell their projects once they are complete.
“There is a lot of financial strength here,” Carnahan said. “These developers believe in their projects.”
The next few months could make for an interesting negotiation environment, brokers say.
“We’re still another six months away (of limited leasing) before (landlords) blink,” said Kurt Strasmann, managing director of local operations for Grubb & Ellis Co.
The local office market still is in favor of landlords, even if the velocity of the market has slowed down, according to Strasmann.
“It could be a difficult 12 months after that, but then it is likely to go back to being a landlord’s market,” he said.
Expect to see concessions first offered on tenant improvement work, and then perhaps rent abatements.
Strasmann said he doesn’t think the market will see any cuts in rent.
The average monthly asking rent for higher-end office space in the county cracked the $3 per square foot mark in April, up from $2.70 per square foot a year ago, according to the latest figures from Grubb & Ellis.
The new towers are expected to command monthly rates in the $3.50 per square foot and higher range. No one appears ready to budge.
“My understanding is that (other developers) will hold their rates at $3.50 (per square foot) or above,” Rutter said.
While many office developers around town have yet to land the big-name, multi-floor tenant, it isn’t the end of the world, said Rick Kaplan, executive director for the Irvine office of Cushman & Wakefield Inc.
“The velocity of smaller leases,10,000 square feet or less,is still strong.”
Kaplan’s handled leasing for much of the office space being built at the Impac Center in Irvine.
“Much of the growth here is organic,” Kaplan said.
Broadcom Corp. started out with a modest 5,000-square-foot lease in Irvine, as did many of the area’s mortgage companies, he said.
The chipmaker recently moved into 685,000 square feet of space at the Irvine Co.’s University Research Park.
“We’re still seeing activity in the (smaller tenant) range,” Kaplan said.
Expect to see the model used by Hines and partner Crescent Real Estate Equities Co. of Fort Worth, Texas, for their 2211 Michelson office towers as the most likely blueprint for the other developers.
Hines signed on Pathway Capital Management LLC, an Irvine-based investment manager, for 37,250 square feet, or about two floors, in January.
It followed that deal up in March with a 25,400-square-foot lease for Wachovia Corp.
While the developer still is looking to land other large tenants, it’s now focusing on leasing space in a series of smaller deals, brokers said.
“You’ll see one or two big deals for each of the buildings, followed by a number of smaller leases, 5, 10 or 15 thousand square feet,” Kaplan said.
