Investors and tenant brokers appear to be of two different minds when gauging the health of Orange County’s office market heading into 2014.
The country’s largest institutional real estate investors have made OC a go-to location in the past four months, with more than $400 million spent on several of the area’s better office properties of late.
The deals are largely being underwritten on the expectation that the local office market, which with a few exceptions has clearly favored tenants over the past five years, is finally poised for an increase in rents over the next few years.
“Coupled with the current construction activity and an active sales environment, landlords have many reasons to feel optimistic about the road ahead,” said a recent office report by the Irvine office of Jones Lang LaSalle.
Those who do lease negotiations with landlords don’t necessarily share that sense of optimism.
Tenant brokers are predicting much less robust rent growth, if any, in the immediate future for the county at large and said they feel the office market still isn’t close to fully recovering from the effects of the last recession.
“They probably are right that rents will go up, but I don’t think it will happen as soon as they think,” said Randall Parker, president of Travers Realty Corp., a tenant brokerage with offices in Newport Beach. “The horizon is going to be a lot longer out than they expect.”
Tenant brokers’ reasoning takes note of modest job growth in the area, particularly for office jobs, as well as a sluggish leasing environment.
They also expect several large tenants in OC’s office market, including lenders and Hyundai Motor America, Pacific Investment Management Co., CashCall Inc., could soon give back large chunks of space they currently occupy, either due to new offices coming online or to downsizing.
“Most tenants still have a wide range of options to consider and significant negotiating power,” said Royce Sharf, executive vice president for the Irvine office of tenant brokerage Studley Inc.
“It’s an odd time. It’s a seller’s market, and at the same time it is still a tenant’s market,” he said.
A new Studley report said “many tenants are taking a wait and see approach, and delaying space use decisions if they can, or even signing short-term leases.”
On the other hand, “if you have the visibility, tenants should go as long as they can (with leases),” Sharf said.
Active Sales Market
Investors haven’t taken a wait-and-see approach, based on the volume of sales transactions so far in the second half of the year.
Six deals in excess of $50 million have closed since July, one of the busier stretches of investment sales not featuring distressed properties that OC’s office market has had in years.
The buying binge was capped by last month’s sale of the 2030 Main Street tower in Irvine. That building went for a little more than $114 million and is OC’s largest office transaction of the year.
The Praedium Group LLC, a New York-based investor that just started a new real estate fund focused on core assets, bought the building on the expectation that local office market rents will increase over the next few years.
“This is a core deal for them in a core submarket,” said Kevin Shannon, vice chairman and managing director for Los Angeles-based CBRE Group Inc., whose brokerage team marketed the tower for sale. “They’re forecasting strong rent growth, better than most markets in L.A.”
Conditions in Buyers’ Favor
The rent growth projections are based on several factors. Vacancy rates are now at their lowest point in more than three years, about 15%, based on a sampling of area brokerage data.
Plus, Orange County’s office sector has now seen 14 consecutive quarters of positive absorption and about 1 million square feet of positive absorption so far this year, a sure sign of a strengthening market.
Rents, despite those improvements, have yet to fluctuate much. Average asking lease rates have remained flat for nearly three years, according to CBRE, and despite pockets of rising rental rate growth, the countywide average remains at less than $2 per square foot, according to CBRE data.
That could begin to change.
The Irvine office of Newport Beach-based Voit Real Estate Services is projecting that the county’s average monthly asking office rent, which is now $1.91 per square foot, will inch up a penny by the end of the year and end 2014 near $1.95, a 2% increase.
“As job creation continues and consumer confidence stabilizes, the office market will continue to recover,” Voit Vice President of Market Research Jerry Holdner said in the brokerage’s third-quarter office market report.
Institutional investors, flush with Wall Street cash, appear similarly convinced of rising rents, based on their recent buys here.
“There’s a lot of capital attracted to the market right now,” Shannon said.
Large national investors taking an interest in OC, in addition to Praedium, include AEW Capital Management LP, Cornerstone Real Estate Advisors Inc., Goldman Sachs Asset Management and Griffin Capital Corp.
International buyers, which scooped up a number of properties here last year, have been less of a presence this year.
Chicago-based Equity Office Management LLC, OC’s second-largest office landlord before cashing out on its local portfolio near the peak of the last commercial real estate cycle, is also on the hunt for local properties.
It’s backed by private equity giant Blackstone Group LP of New York and has spent about $180 million on local office buys since June, including last month’s $75 million purchase of South Coast Corporate Center, a three-building complex near the South Coast Plaza shopping center in Costa Mesa.
The latest deal “furthers our strategy to acquire high-quality assets in growth-oriented submarkets,” said Frank Campbell, managing director for Equity Office’s Southern California operations.
“We look forward to providing additional opportunities to serve our clients in our expanding Orange County portfolio,” said Campbell, whose company is said to be considering deals in other parts of OC, as are other institutional investors.
The largest offices now on the market are in Central County, where a quartet of buildings totaling about 1.1 million square feet are being shopped.
The buildings—City Tower, 500 Orange Tower, Stadium Towers, and 3800 Chapman—are expected to fetch close to $275 million combined.
Local Firms Losing Out
Locally based real estate companies have largely been forced to the sidelines for larger sales recently due to the interest of aggressive national investors.
The biggest deal by an OC-based investor in the second half of the year took place in August when Newport Beach-based Olen Properties Corp. paid $73.5 million to buy the Irvine Oaks Executive Park, a 16-building office park in the Irvine Spectrum.
Olen President Igor Olenicoff said the all-cash deal for the 322,000-square-foot park, whose largest tenant is Blizzard Entertainment Inc., was made at “a very fair price.” He said the company planned to keep the property as a long-term investment, which isn’t necessarily the strategy of other institutional investors recently buying into OC’s office market, several of whom are likely to sell the properties within a few years.
Irvine Oaks has “significant upside on a long-term hold,” Olenicoff said at the time of the purchase.
“We are gratified for being the selected buyer, in that we know there was great interest in the asset from institutional buyers.”
