MARKET HIGHLIGHT, JANUARY 2005

THE O.C. ALSO MEANS PRIMETIME REAL ESTATE
Ian Brown, Jerry Giglio, Chris Deason and Louis Tomaselli

Orange County’s retail sector leads the way with high tenant demand and low supply driving asking rates. The market’s ever-increasing demand for housing, coupled with a shortage of apartment construction, has caught the attention of many multifamily investors. Rising rental rates and a scarce amount of product have produced a condominium development trend in both Orange County’s improving office market and its strong industrial sector.

Retail

During 2004, Orange County’s retail sector outperformed all other commercial real estate sectors in the market. Currently retail vacancy is hovering at around 4 percent while asking rates for all types of centers remain at an average of $2.10 per square foot per month, with some submarkets experiencing rents as high as $3.50 per square foot. Key economic data suggests that retail should continue to outperform all other real estate sectors throughout 2005.

Median household income in Orange County has always been higher than the national average and is expected to increase in the future. This has attracted a wide range of retail tenants and should continue to push vacancy rates lower. The lack of existing retail space in Orange County has increased average asking rents, making it one of the most expensive retail markets in Southern California.

Current market conditions should continue unabated even though a couple of major developments are in the works. Foremost among these projects is the large mixed-use redevelopment planned for the former Tustin Marine Corps Air Station, which will feature a 1.1 million-square-foot mall. While this shopping center is expected to attract nationally recognized tenants, it is also expected to have a significant impact on the Orange County retail inventory. However, increased confidence in the national economy along with feverish retail demand will cause the absorption of any newly constructed space. Long-term construction projects remain on track even as the rise in long-term interest rates and increased construction costs threaten the local economy.

Major tenants driving demand are Lowe’s Home Improvement Warehouse, The Home Depot, Target and Costco. These retailers are making an aggressive push to open new locations throughout the county and nation. Their commitment to the market is attracting investors and other tenants to anchored shopping centers. Most of the activity is occurring in the affluent south and central coast areas.

The long-term health for Orange County retail faces some serious challenges, including increased construction costs, higher interest rates and less than spectacular job growth. However, in the short term, the area will continue to flourish because of its appealing demographics. Confidence in the retail sector is further supported by landlord insistence on higher asking rates, which are expected to increase by 3 to 5 percent in 2005. Challenges aside, Orange County can be expected to benefit from low supply and high tenant demand.

— Ian Brown is a senior vice president in Grubb & Ellis’ Newport Beach office.

Multifamily

Southern California has established itself as the premier residential market in the nation, with Orange County leading the way. Increasing housing demand, coupled with the market’s limited multi-housing construction, has fueled investor demand throughout the region.

Increasing home prices have boosted demand for rental housing throughout the county. The lack of new multifamily development in the market has created a paucity of available rental housing. This backlog of product, which translates into future rent increases, has motivated scores of local and out-of-area investors to invest in apartment properties of any size. The “Real Facts” third quarter update shows a 4.8 percent increase in average rents since 2003, and countywide occupancy currently stands at a remarkable 95.7 percent. Average rental rates have risen to $1,317.

With vast amounts of capital pursuing a limited supply of offerings, multifamily housing investment pricing has remained high, increasing more than 10 percent since 2003. At the same time, cap rates continue to remain very low, averaging only 5.5 percent year-to-date 2004. In spite of these high values, most apartment owners have been reluctant to sell due to a lack of viable alternative investment opportunities.

Newly approved mixed-use zoning plans have created a land rush atmosphere for development opportunities in two key areas of Orange County: Anaheim’s Platinum Triangle and The Irvine Business Center. The Anaheim plan allows for residential development up to 100 units per acre. High developer demand has caused the land values to exceed $4 million per acre. Lennar Communities has led the way in both submarkets with aggressive condominium development plans.

Apartment construction has been negatively affected by the high land values forcing developers to redirect their focus to the construction of multi-story, for-sale condominiums, rather than rental apartments. Local municipalities are supporting the acquisition of infill sites by residential condominium developers.

There are currently more than 25 adaptive reuse projects in progress in Orange County, including DR Horton’s planned conversion of a retail center to a low-rise condo complex in Garden Grove; Legacy Partners’ planned conversion of a multi-tenant building to a mid-rise condo development in Irvine; Nexus Properties’ planned conversion of a major retail and office corner to a mixed-use development, with the major component being residential condos; and Brookfield Homes’ planned conversion of an RV Park to townhomes in Anaheim.

Market trends point towards continued growth in property values in 2005. Cap rates may slightly increase, but rent increases should continue to support increasing property values.

— Jerry Giglio is a vice president in Grubb & Ellis’ Anaheim office.

Office

Lease rates continue to rise in the Orange County office market as available office product dwindles. The average office lease rate is $2.05 per square foot per month, which is an increase of 2.5 percent from last year.

Large portions of office-zoned land in Orange County have been snatched up and converted into residential apartments and condominiums. There are only 458,310 square feet of office product currently under construction, a decrease of more than 28 percent from last year. The office vacancy rate is at 10.5 percent, which is 3.5 percent lower than a year ago.

With increasing rental rates and little available office product, more small owner-user office condominiums are likely to be developed in Orange County. An example of this trend has already been seen in the medical office market. With little medical product available, medical office developers started building condominiums, creating more product with the available land in order to satisfy pent-up demand.

The condo trend also makes sense because small owner-users are dominating the Orange County office market. With low interest rates, small owner-users are buying office buildings with fixed terms and conditions over a 25-year period. Office condominiums ranging from 2,000 to 3,000 square feet are becoming the most popular.

High-rise office rental rates have increased 5 percent from 1 year ago. These increases could be slightly softened because construction has been approved on One Broadway Plaza, a 37-story high-rise office building in Santa Ana, which will be Orange County’s tallest building upon completion.

Office sale prices are increasing with the average per-square-foot sale price at more than $186. Despite these increases, office sales are still on the upswing. In 2004, the largest office sale was $106 million for a 326,000-square-foot office building located at 4020 Main Street in Irvine.

South Orange County, spanning from the Irvine Spectrum area to the city of San Clemente, and the Airport submarket, which covers the cities of Corona del Mar, Costa Mesa, Irvine and Newport Beach, are the two sections of the market with the most office activity, totaling just over 2 million square feet of positive net absorption for the first three quarters of 2004.

— Chris Deason is a senior vice president at Voit Commercial Brokerage.

Industrial

The Orange County industrial market hit a new high of nearly 3 million square feet of net absorption for the first three quarters of 2004, exceeding similar periods during the past 3 years.

The sector’s industrial vacancy rate of 4.76 percent is almost 20 percent lower than a year ago. This capital-rich investment market is seeing continued success across the board with institutional investors, private investors, development companies, 1031 exchange groups, TIC (tenants-in-common) entities and REITs all participating.

One major industrial trend is the growth of small for-sale, owner-user industrial product under 10,000 square feet. With little raw land available for industrial development, developers are acquiring large industrial buildings and redeveloping them into small for-sale, owner-user industrial condos.

There are several examples of this market direction. BKM Development Company acquired a three-building, 150,000-square-foot industrial project in Costa Mesa and is redeveloping the buildings into 19 for-sale condominiums to be completed later this quarter. Voit Development Company is currently redeveloping 500,000 square feet of the former 1 million-square-foot Steelcase facility into Tustin Gateway Business Park, a 19-building industrial park that will feature both freestanding and condominium product. Werdin Corporation has developed Pacific Business Center, a 12-building industrial park in Tustin. All 12 buildings have already been sold. Net Development Company has purchased two large industrial buildings, which it is currently redeveloping into small for-sale industrial condominium product within the Irvine Industrial Complex.

The industrial lease market, which has been slow for the last 2 years, is now strengthening with the improving economy and low vacancy rates. The average triple-net lease rate is 56 cents per square foot per month, an increase of almost 10 percent from last year.

With only 565,468 square feet of industrial product — only a third of last year’s total — currently under construction, existing properties will become more valuable. This will increase for-sale and for-lease rates. As interior rates start to rise, the for-lease market could provide a lower cost alternative for small business owners.

North Orange County, which encompasses the cities of Anaheim, Brea, Buena Park, Fullerton, La Habra, Orange, Placentia and Yorba Linda, remains the section of the market with the highest net absorption for 2004, a total of 1,319,674 square feet. The Airport area, comprising the cities of Costa Mesa, Fountain Valley, Irvine, Newport Beach, Santa Ana and Tustin, is a close second with 1,213,778 square feet of positive net absorption.

— Louis Tomaselli is a senior vice president at Voit Commercial Brokerage.

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