Advantage landlords.
That’s the picture that emerges from the most recent data on Orange County’s roughly 100-million-square-foot office market, which wrapped up the first quarter in its strongest position since the onset of the Great Recession.
Average asking rates were up sharply on quarterly and annual comparisons, according to the latest quarterly date from CBRE Group Inc.
Vacancies also fell close enough to a key benchmark to suggest that OC might soon see a return of speculative development beyond recent select moves made by Newport Beach-based Irvine Company, the dominant landowner and office landlord here.
The 3.4% quarter-to-quarter increase on lease rates was the largest since 2007, just before the recession took full hold in OC. The gain put the countywide monthly average at $2.12 per square foot, according to CBRE’s data.
The hike came to 7.6% on a year-to-year basis—the largest jump since late 2007.
The trend has been gaining strength for several quarters, and it’s expected to put a clear stamp on the market this year, according to Kurt Strasmann, senior managing director in Orange County for CBRE.
“The needle is moving very rapidly on lease rates with continued exceptional demand from office space users,” Strasmann said. “The lease rate appreciation momentum has been prevalent for the last six months of 2014, but 2015 will be known as the breakout year when lease rates really jumped.”
There are still some relative bargains to be had for now, even with the recent rent increases. Brokerage data indicate that lease rates are still nearly 20% below where they stood at the peak of the last cycle, when the average ran close to $2.75 per square foot.
“There’s still an opportunity to capitalize (on good deals), but tenants need to be very deliberate and move very quickly,” said Randall Parker, a partner with the Newport Beach office of tenant brokerage Cresa Partners.
In particular, upper floors of high-end office towers are in short supply for tenants seeking space that comes with both prestige and good views, Parker said.
Vacancies
The quickened pace of improvement can be seen in the 1 million square feet or so of positive absorption in the first quarter of the year, according to CBRE’s data.
That’s more than 50% of the total net absorption in all of 2014.
The absorption rate helped push down vacancy rates, which ran close to 20% amid the recent recession and the region’s subprime mortgage meltdown.
CBRE’s research puts the current vacancy rate at about 10%, which is close to a prerecession level. A sampling of data from other area brokerages puts vacancy rates here between 11% and 13%.
The 10% mark is generally seen as the point where market conditions swing from favoring tenants and give landlords an edge in negotiations for lease rate and concession packages, according to most industry watchers.
“The office market in Orange County has been shifting towards a landlord’s market for the past few quarters,” said Gary Baragona, CBRE’s director of Research and Analysis in Southern California.
Developers also tend to avoid speculative development until they think they can deliver a new building into a market with vacancy rates near the 10% mark or lower.
Higher monthly rents—in the $3-per-square-foot range—are typically needed to justify the cost of constructing a building.
Irvine Co. recently finished a speculative office tower in Newport Center and has a 21-story building of about 425,000 square feet on track to open early next year in the Irvine Spectrum. Recent plans filed with the city indicate the developer is in the early stages of planning another office tower in the Spectrum.
Those, along with a couple of office projects said to be on the drawing board for the area around John Wayne Airport, are a far cry from the speculative market of the last real estate boom.
The Spectrum and airport area saw a skein of six speculative office towers open in the year or so before the recession. They added more than 1.5 million square feet of space to an office market that was about to feel the effects of the implosion of the mortgage industry, which accounted for big chunks of empty space throughout OC.
Those factors contributed to the OC office segment’s quick shift to a tenant’s market.
Tenant Diversity
A big difference in today’s office market: tenant diversity, according to CBRE’s Strasmann.
“The office market in Orange County is a dramatically different place than it was … when our tenant base was dominated by the mortgage industry,” Strasmann said. “We were far more vulnerable between 2006 and 2008 when one industry drove a large portion of office space absorption. Today, we are a very diverse market.”
Healthcare-related companies have replaced subprime mortgage firms as the dominant office tenant in Central Orange County, while medical and nonsubprime-related financial service companies, are among the biggest sources of new leases in the airport area.
Look for entrepreneurial and research-oriented businesses—such as IT, defense, medical and alternative energy companies—to lead the charge of positive absorption over the next few years, according to a quarterly office report from the Irvine office of Voit Real Estate Services.
