MARKET HIGHLIGHT, JANUARY 2008

ORANGE COUNTY
John Read, John P. McDermott, Damon Wyler, Brian Sperry and Shane Shafer 

Location, a diverse population, long-term performance and strong fundamentals mean that Orange County can weather just about any economic storm. It also means the market will remain high on the target list of tenants and investors.

Industrial

Whether it is ground-up development or the repositioning of an existing property, the prominent trend in Orange County’s industrial market is to deliver smaller, for-sale product for user-buyers. Local small business users have a consistent need for space as they contend with high prices, rising rates in the lease market and low levels of available space.

CoStar reports vacancy at a low 3.9 percent as of third quarter 2007 and asking rents at $0.87 per square foot or an average $1.26 per square foot for flex space and $0.77 per square foot for warehouse space. While Orange County is a prominent smaller space market, three large space leases are the 274,088-square-foot commitment by The Home Depot EXPO Design Center in Buena Park, the 238,720-square-foot lease to Quaker Oats Distribution, also in Buena Park, and the 258,506-square-foot lease to B. Braun Medical Inc. in Garden Grove.

While developers capitalize on small owner-user space, larger building developments like Overton Moore Properties’ Pacific Gateway Business Center in Seal Beach are not as common due to the lack of available land and high land prices. Smaller building projects are abundant and are largely taking place in the northern part of the county. These include Burke Development’s The Citrus in La Habra, Lowe Enterprises’ Kimberly Business Center in Fullerton and Guthrie Development’s 28-building Guthrie Lambert Business Center in Brea. Chasing repositioning opportunities, M2 Properties is converting a 70,000-square-foot warehouse to for-sale industrial condos at Valencia Business Center in Tustin and a 95,000-square-foot warehouse to for-sale office and industrial condos at Von Karman Center in Irvine.

While asking prices for smaller space can run in the $200 to $300 per square foot range, CoStar reports values increasing across the board from $124 per square foot in mid-2006 to $135 per square foot in mid-2007.

Though Orange County volume has decreased from 62 transactions and $386.47 million in first half 2006 to 50 transactions and $317.27 million in first half 2007, buyers are still hungry for industrial investments and development projects. One of the largest local investment deals of the year was Walton Street Capital’s purchase of the RREEF/Calwest Industrial portfolio, of which 3.3 million square feet valued at $400 million+ was in Orange County. Two recent transactions that are an indicator of investors’ appetites for well-located, quality industrial real estate in the county are Voit Development/Buchanan Street Partners’ $57 million purchase of the 428,000-square-foot 17871 Von Karman Ave. in Irvine and Don Wilson Builder’s $34 million purchase of the 144,185-square-foot Goodyear Business Park in the Irvine Spectrum that was purchased vacant upon completion of construction.

Most universally accept that challenges in the finance markets and greater economic uncertainty lie ahead, which will force Orange County industrial buyers to look at deals more closely and underwrite them less aggressively. While these issues have the potential to affect users and tenants as well in terms of their businesses and affordability of space, the outlook for the local industrial market remains strong, thanks to underlying fundamentals, diverse population, location and long-term performance.

— John Read is a vice president in Sperry Van Ness’ Irvine, California, office.

Office

The national office market changed dramatically in third quarter 2007 due to the credit crunch and stall in the CMBS marketplace. This untimely major adjustment in the capital market caused by the widespread impact of the subprime mortgage debacle created an even greater ripple effect throughout the capital market worldwide, but was especially impactful on the Orange County office market where the major office tenancy was subprime lenders, mortgage companies, mortgage brokers and related service providers (title, escrow, appraisal, insurance, etc.).

In the real world of commercial real estate, as the cost of money rises and its availability becomes more challenging, the cap rates on the properties being offered must increase, prices must drop or offerings will either be removed from the market in a wait-and-see approach or the offering will simply just stay on market. Market cap rates have averaged 6.1 percent during the past 12 months, and the price per square foot has averaged a healthy $252.70.

Central business district and Class A office buildings have performed better than suburban office properties, and smaller deals have experienced bigger adjustments in cap rate increases and price reductions or concessions accordingly. Institutional quality properties continue to have little value reduction — and many institutions sold as a result, taking their profits off the table — bolstered in a significant way by foreign capital buyers and those institutions with a long-term hold mentality.

Clearly the mantra of the Orange County market today is a flight to quality in all product types, but especially in office. Just as the foreign investors and institutions are buying in Manhattan and San Francisco, even in smaller markets and the suburbs, the better property in superior locations are being bid on by multiple buyers represented by multiple brokers.

Underwriting and due diligence are returning to the fundamentals of real estate acquisition, and the scrutiny of the buyer has returned to the norm versus the frenzy created by cheap and overly plentiful capital in the hands of numerous competing entities, both private and professional.

Vacancy had reached single digit levels due to the demand for office space continuing at a moderate rate and little or no new space coming on line, allowing absorption to be positive. The double impact Orange County now faces is nearly 5.5 million square feet of office coming on line in the next 18 months, a very significant amount of sublease space available and slow or moderate office job creation.

Major market office transactions included the $130 million sale of 386,000-square-foot Orange City Square in South Orange by Mass Mutual Life to Birtcher Anderson Properties ($337 per square foot); the $51 million sale of 155,484-square-foot Jamboree Business Centre East in Irvine by Allianz of America to TA Associates Realty ($329 per square foot); and the $43 million sale of 156,000-square-foot Palm Terrace in Lake Forest by Tishman Speyer to Alaska Permanent Fund Corporation ($276 per square foot).

2007 sales of Orange County office product exceeding $1 million have included 230 transactions totaling a very significant $4.728 billion. The lowest price per square foot of any transaction in 2007 was $95, and the highest recorded price went to an office/live-work property at the Cannery Lofts in Newport Beach at $1,158 per square foot, proving once again that location and quality do matter and will continue to well into 2009.

— John P. McDermott is a senior vice president and national director, office and industrial properties, for Sperry Van Ness Commercial Real Estate in Irvine.

Retail

Though the Orange County retail market in the last 12 months has seen a 5.8 percent reduction in transaction volume, a mix of constrained development opportunities, healthy economics and affluent consumers upholds its position as a safe haven and leader among U.S. retail markets that remain in flux.

According to CoStar, Orange County’s average vacancy rate sits at just 2.8 percent, while REIS reports average rents at $31 per square foot, though landmark projects like Fashion Island and the Irvine Spectrum can exceed $64 per square foot.

Jockeying for position, developers in 2007 delivered 2.1 million square feet of new retail space, including the 300,000-square-foot South Coast Home Furnishing Centre, built in Costa Mesa’s South Coast submarket by local Birtcher Development; the 1.1 million-square-foot District at Tustin Legacy, built by Phoenix-based Vestar Development, Kimco Realty and Bank of America within a 1,600-acre mixed-use master plan at Jamboree Road and Barranca Parkway in Tustin; and the 450,000-square-foot Woodbury Town Center, built by local giant The Irvine Company at Irvine Boulevard and Sand Canyon Avenue.

Reflecting demand, these properties are at or near 100 percent occupancy with tenants like CostCo, Lowes Home Improvement Warehouse, Target and Whole Foods Market at Tustin Legacy, and The Home Depot, Ralphs and Walgreens at Woodbury. Both Tustin Legacy and South Coast also reflect a trend toward infill, with the former occupying a portion of Tustin’s Marine Corps Air Station and the latter built on the site of a former State Farm Insurance headquarters.

In third quarter, South Coast Home Furnishing Center sold to locally based Leasco Investments for $100 million, a solid transaction in a market where tightened lending standards and reduced yields have removed significant capital from the investment scene. This is particularly true among institutional investors, who are building their war chests and waiting out the next 12 to 24 months in hopes of more opportunistic buys.

Retail builders also are showing restraint, with slightly more than 1 million square feet underway. Infill markets remain the hot spots. This includes San Clemente, where Newport Beach-based Craig Realty is building the 650,000-square-foot Plaza San Clemente within the Marblehead master-planned community; in Anaheim, where Chicago-based Urban Retail and San Diego’s Excel Realty in mid-2008 will complete 440,000 square feet of retail at Anaheim Garden Walk, a mixed-use project at the front steps of Disneyland; and in Huntington Beach, where rezoning efforts on Beach Boulevard and the planned addition of multifamily space at Bella Terra mall should attract more, particularly mixed-use, construction.

But development and investment will continue to operate differently in this coastal location. As tertiary markets are harder hit during shifts, Orange County will persist with its higher-priced but very stable retail foundation, where vacancy factors clearly show room for more. The successful Orange County investor will accept these higher costs and slower returns, and will consider value-add projects offering opportunity for increase yields. The rest can be left to Orange County, whose fundamentals and demographics provide protection from the nation’s otherwise fluctuating retail marketplace.

— Damon Wyler is a vice president and Brian Sperry is an advisor for Sperry Van Ness in Irvine.

Multifamily

Though Orange County’s multifamily submarkets can vary widely by character, they all share a market where demand drastically exceeds supply and where the ability to raise rents is the benefit to ownership.

Orange County’s multifamily vacancy sits in the 4 percent range, though that figure can range from as low as 3 percent to as high as 5 percent, depending on size and age of a building. The average rent in Orange County is $1,479, up 6 percent from 2006. Cities like Placentia, Orange and Westminster lead with an average of 8 percent rental growth while Mission Viejo and Brea average around 3 to 5 percent. The coming year looks to continue this trend, with expectations of a 5 to 7 percent increase in rents on average countywide.

This keeps Orange County high on the list among new investors, who want to own apartments here, and encourages those currently operating in the area to continue to be bullish in pursuing opportunities. Many owners are looking to upgrade or add to their portfolio within the county as well as move into newer buildings. Alternatively, other investors are looking to buy older properties and maximize returns through upgrades to interiors or improved amenities, like a new leasing office or gym. The improvements create opportunity to increase rents and improve returns.

Currently, apartments are selling in the mid- to lower 4 percent cap rate range for Class A and B properties. Class C properties are in the higher 5 percent cap range. Areas like Santa Ana, Fullerton, Tustin, Buena Park and Anaheim are particularly active for investors to buy in, due to the constant and strong fundamentals.

To meet the increased demand among renters, developers are looking to build properties like the new 820-acre development project in Anaheim called the Platinum Triangle, where apartments and mixed-use residential space have created an increase in values for property owners in Anaheim and adjacent cities. The project will strengthen the diverse and robust employment base and add to the desirability and quality of life in Orange County.

As investors continue to add value to apartments to meet Orange County renter demand, they further improve the overall quality of this market’s multifamily inventory. That in turn builds even greater stability into the Orange County’s short-term performance and virtually ensures the kind of long-term growth that will continue to keep Orange County on the top of multifamily investor lists.

— Shane Shafer is a vice president at Sperry Van Ness in Irvine.

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