ORANGE COUNTY
A huge resurgence of demand was evident in the Orange County office and flex-tech markets in the second quarter, resulting in positive fundamentals that reach well beyond expectations. The “wait and see” attitude that characterized tenants and landlords in the second half of 1999 has given way to a sense of renewed confidence and urgency. Pre-leasing continues to be strong in both high-rise office and low-rise flex-tech developments. Asking and effective lease rates are climbing, and space is being absorbed at a record pace.
Once again, the local economy is in the driver’s seat and the pedal is to the metal. Taxable sales in California are up 13.4%, compared to the first quarter of 1999, to $98.9 billion,the biggest increase since 1984. Rising personal incomes, which have increased 6.5% nationally since last year, have enabled consumers to spend more discretionary dollars. Resulting inflationary fears have been eased by a 0.1 percentage point increase in the Consumer Price Index in May, proceeded by no increase in April.
Unemployment statistics for Orange County are equally encouraging, thanks to a 3.3% increase in jobs over the past year. Large increases in services (14,600 new jobs), government (9,600 new jobs) and manufacturing jobs contributed to this improvement. As a result, the unemployment rate in May stood at 2.3%, the lowest in Southern California.
Substantial increases in international trade, particularly with the reemerging Asian economies, will continue to create new jobs in the increasingly diverse Orange County marketplace. International air cargo at LAX has increased by 13.3% over a year ago, while the ports of Long Beach and Los Angeles report year-to-year export gains of more than 11%.
Perhaps the most dramatic indicator of local economic health is that foreclosures have declined in Orange County by more than 46% during the past year. Businesses are financially healthy and expanding, consumers are making and spending more money and the Orange County office market, in turn, is performing at a high level.
Evidence of the strong Orange County office market can be seen within almost every building, but is highlighted within the quarter’s statistics. Vacancy rates defied the addition of more than 1 million square feet of newly completed construction by descending significantly in both the office and flex-tech arenas. Office vacancy dipped from 9.5% in the first quarter to 8.2% in the second quarter, the lowest overall vacancy rate ever recorded in the OC office market by Grubb & Ellis.
The flex-tech market witnessed similar results. Flex-tech vacancy dropped from 19.0% to 16.3% in the quarter. Typically, vacancy will increase temporarily in periods of heavy construction. Unusually strong pre-leasing, however, has enabled many new speculative projects, such as LNR Newport Plaza and Serrano Creek Corporate Center, to be almost fully occupied upon completion. Second-generation opportunities, such as the 200,000-square-foot space at 555 Anton in Costa Mesa that was recently filled by BMC Software, have enjoyed impressive activity and successful leasing.
Tenant demand has resulted in the strongest quarter of absorption in more than a decade. Nearly 1.2 million square feet of office inventory was absorbed, while more than 600,000 square feet of flex-tech space was filled. More than 90% of the total absorption, including office and flex-tech space, occurred in the Airport Area and South County submarkets, where high-tech companies are expanding at a dizzying pace. Nearly 50% of the leases signed in these submarkets during the second quarter involved Internet-related companies.
While supply is diminishing, lease rates are rising. Overall, office rates increased 3.0% this quarter to $2.10 per square foot per month, full-service gross, while flex-tech rates jumped 5.6% to $1.51, triple-net. The most significant escalations followed absorption to the Airport Area and South County submarkets, where rates increased 3.5% in office and more than 6.0% in flex-tech buildings due to the completion of several new Class A projects and the absence of available space.
Available space is extremely tight in the Orange County industrial and R & D; market due to a resurgence of demand during the first half of 2000. Asking lease rates and sale prices are climbing, and space is being absorbed at a steady pace.
The surge of demand that hit the Orange County market in the first quarter has continued to intensify as desirable space quickly disappears. Second-quarter activity swelled to a combined 6.7 million square feet, with more than 4 million square feet absorbed in the industrial market alone. Year-to-date activity is equally impressive, nearly tripling the amount observed during the same period last year. Sale and lease activity has been especially strong in North County industrial buildings of 10,000 square feet to 25,000 square feet, and R & D; facilities in South County larger than 100,000 square feet. Both categories experienced more than 1 million square feet of sale and lease activity, and have the lowest vacancy rates in the county at 6.2% and 5.3%, respectively.
Private users and investors have shown a great deal of interest in smaller product, while large tech-related companies vied for extremely rare big-box industrial and R & D; space. While development is under way to relieve pent-up demand for smaller space, 15,000 square feet to 50,000 square feet, big-box development has waned. Available industrial land is almost nonexistent in the county, so developers have been constrained to building the most profitable projects. Industrial construction stands at nearly 1.3 million square feet, while total R & D; construction, without flex-tech product, totals only 600,000 square feet. Both numbers are a 45% decline in construction since midyear 1999.
The frenzy of activity in the Orange County market brought R & D; availability down to 7.8% and industrial availability to 8.3%. Near-record lows in available space have caused lease rates to rise steadily and sale prices to skyrocket, especially for new construction. Sale availability is especially tight because more tenants are taking advantage of favorable market conditions and plentiful capital from the Small Business Administration to become owner-users. SBA loans are available largely for acquisitions ranging from $500,000 to $2 million.
LOS ANGELES
The Los Angeles County office market vacancy rate continued to drop in the second quarter, with the average rate for all of the county’s 162 million square feet down almost two full points year-to-year, at 12.9%. Vacancy reductions were most dramatic in the South Bay and Tri-Cities markets. The South Bay benefits from its location and rapidly diminishing surplus of office space at relatively affordable lease rates. The South Bay market accounted for more than 60% of the suburban market net absorption this quarter.
The West LA office market has a rock-bottom vacancy rate (5.8%) coupled with strong and growing demand for office space. Bucking the downward trend in vacancy is the downtown market, where the rate increased by two points this quarter, yet again the victim of sublease space thrown on the market by mergers and corporate consolidation. Much of the new sublease space is short-term, and as a result will not have an adverse effect on the direct leasing market.
A moderate supply of new office development is under way in the county’s office markets. At the close of the second quarter there was a total of 3.3 million square feet of new office space under construction that, when completed, will add only 2% to the inventory.
New office projects are being developed in the West LA, Tri-Cities, and North LA markets. Rapid absorption of new space has been achieved and is expected to continue as strong demand is evidenced in pre-leasing activity.
Robust demand for office space and diminishing availability has sent lease rates climbing. The average asking rate for Class A office space in all of Los Angeles County has risen by 7.3% since the second quarter of 1999. Rate increases vary by market, with double-digit increases in the Tri-Cities, and 9% increases in North Los Angeles, downtown, and the South Bay.
The Central Los Angeles industrial market has more than 265 million square feet of warehouse and manufacturing product, which has been at rock-bottom vacancy for the past several years. As of the second quarter, the vacancy rate has increased to 3.5%. Extremely tight supply conditions have had an effect on average lease rates, which shot up by almost 17% in the past 12 months.
In the South Bay, reduced availability of modern industrial space moved asking lease rates up 15% to 20% last year. Lease rates will have more upward pressure and new development cannot be delivered as fast as demand for space is growing. As of the second quarter, vacancy has dropped to 3.8%, a confirmation of strong demand for the 2.9 million square feet of space under construction. The San Gabriel Valley market also has minimal available supply and asking lease rates that rose by more than 20% during the past year.
Development activity will add 2.4 million square feet of space to the LA industrial market during 2000. This level of new product will not be enough to ease the supply constraints in the market and meet growing demand.
As of the second quarter, industrial vacancy in the San Gabriel Valley was still a very low 3.9%. Developments under way in the North Los Angeles market will deliver 1.4 million square feet of new product to this sound market. A total of 6.3 million square feet of industrial product was completed in 1999. The new space was rapidly absorbed and vacancy decreased from the first to second quarter of this year, ending at 5.2%. Lease and sale activity is brisk in the Mid-Cities market. Consistent demand has depleted supply and reduced vacancy to 6.3%; the 1.5 million square feet under construction will enable the market to accommodate some users squeezed out of other Los Angeles markets.
OTHER AREAS
The Inland Empire office market continues to improve and strengthen moving into midyear 2000. Vacancy rates, which have been in the mid-20% range for the past few years, are now at 15%, with Class A dropping to 12%. Most of this remaining vacant space is older, smaller Class B and C projects with few amenities.
Due to the uptick in activity last year and into early 2000, the supply of office product has not kept up with demand. High-volume leasing activity has greatly depleted the supply of office product, along with most of the large blocks of contiguous Class A space. As a result of the supply and demand imbalance, more new space will be added to the base in the 2000-2001 building cycle than was added in the past 10 years. As many as eight buildings are under construction, with more in the pipeline.
The majority of this new product is slated for the Airport submarket. However, projects will also be built in the Riverside/San Bernardino, Corona and Temecula submarkets. These newer buildings will offer large blocks of space, along with more efficient floor plans for both new and expanding tenants.
Because of the small size of this still maturing office market, some developers could find themselves positioned in the shadow of too much space hitting the market at the same time. Recently, the newer product has been paced and pre-leasing activity has been increasing.
Moving forward, to keep the market in balance, the timing of completions and steady pre-leasing levels will become even more important. Into late 2000, solid local and Southern California economies will help buoy the market with an increasing and improving job and population outlook.
Moving into midyear 2000, both gross activity and net absorption levels continued performing at a record-breaking pace. Under-construction activity, along with pre-leasing numbers, remained very bullish, with 17 million square feet being built in the total market. An additional 6.8 million square feet was added to the base during second quarter alone, bringing this massive industrial market to 224 million square feet in size. As a testimony to the strength of the market, even with almost 7 million square feet of new product added to the base in one three-month period, the vacancy rate still dropped by a full percentage point, to 7%.
In the second quarter of 2000, the San Diego County occupancy rate reached 5.4%, a record low for the county. Over the past 12 months, the vacancy rate has decreased from 10.3% to 5.4%. This dramatic decrease is the result of more than 2.7 million square feet of absorption in the first half of 2000, which is greater than the total amount of net absorption in 1999. Tenants of all sizes will be faced with a tremendous challenge in their search for new space. With only 1.9 million square feet under construction, the number of opportunities will remain rather limited, especially for tenants with requirements exceeding 20,000 square feet.
Despite recent media coverage about the effects of consolidation among the dot-com companies, the amount of space available for sublease has not changed dramatically and remains less than 300,000 square feet.
The limited amount of available space is having a strong effect on lease rates. Asking monthly rates in Del Mar and University City have surpassed $3.00, full-service. In some submarkets, lease rates are increasing by as much as 10 cents per month. Class A space continues to be in strong demand and has accounted for more than two third of the space absorbed in the second quarter and more than half of the total space absorbed for the year.
Over the last year, the San Diego industrial market has experienced a decrease in the vacancy rate from 11.8 percent to 8.0 percent. The year-to-date net absorption for 2000 has nearly surpassed the total for all of 1999. With only 2.3 million square feet of new speculative space currently under construction and continued strong demand, the San Diego market will continue to be extremely tight for the remainder of the year.
The Fresno industrial market continues to be headed for a stellar 2000. The vacancy rate has dropped from 3.7% at year-end 1999 to 3.3% at midyear 2000. This is one of the lowest vacancy rates the market has seen in several years. Market activity continues to make strides, with more than 700,000 square feet of positive net absorption recorded during the first half of the year.
Bakersfield’s industrial vacancy rate remains low, causing a lack of available product. Industrial land sales are increasing and appear to be owner-user motivated. Lease rates and land prices are stabilizing with a slight increase in selected areas and product.
