MARKET HIGHLIGHT, JUNE 2006

CLOCKWORK ORANGE: CONSTANT DEMAND IN THE OC
Wally Limburg, Roger Kinoshita, Steven Hogberg and Michael Hefner

The Orange County market has a lot of things going for it. The resulting demand means that commercial real estate players must go the extra mile to find the right opportunity.

Retail

Orange County continues to be one of the most sought after retail markets in the country. It used to be considered a laidback residential community removed from the hustle and bustle of Los Angeles, but is now reflective of that urban metropolis due to its population density, freeway commutes, demographic makeup and lack of available developable land.

With the urbanization of Orange County, for the first time in many submarkets mixed-use projects are being built, featuring mid- and high-rise residential towers with retail on the first floor. This product type is most visible around the Orange County Airport and the Platinum Triangle near the Anaheim Stadium, home to the Los Angeles Angels, where more than 10,000 units are planned and under construction for that area. Notable in-fill developments include the redevelopment of the Tustin Marine Corps Helicopter Base in Tustin, encompassing more than 1,600 acres where Vestar Development is developing a 1 million-square-foot shopping center, and 4,600 homes will be built. The other major in-fill development is the 4,700-acre El Toro Marine Base, which was purchased by LNR Property Corporation and will ultimately encompass more than 10,000 homes. These developments are extremely unique in that they are so large and well located amidst some of the best residential and economic pockets in Orange County.

The average home price now is well over $650,000 in Orange County, which is one of the highest in the country. Overall, the market has very little retail vacancy. There is also very little new development taking place, due to the lack of vacant land.

Big box retailers are still providing us the impetus for new shopping center growth in the retail sector, with Target, Costco, Kohl’s, The Home Depot and Lowe’s Home Improvement Warehouse as the leading anchors. Wal-Mart would have more stores in the market, but its size requirements and some public opposition have hindered growth plans.

One of the other retail highlights in the sector is the re-tenanting of the regional malls. Retail sales are at an all-time high at South Coast Plaza, and tenants continue to enjoy double-digit sales growth year after year. Bloomingdale’s will be replacing Robinsons-May at South Coast Plaza, Nordstrom has just opened in The Irvine Company’s Irvine Spectrum Center and JC Penney and Macy’s Home store are coming to Westfield’s MainPlace Mall in Santa Ana. Orange County is also getting its first outlet center, a 400,000-square-foot property developed by Craig Realty in San Clemente.

On top of stout demand, rents are being pushed by ever increasing construction costs. “Infill” continues to be the magic word for retailers in Orange County. The market will continue to be a very vibrant one in terms of growth and retailer demand, and rents, land costs and home prices will continue to increase, at least until there is a major increase in debt cost.

— Wally Limburg is a partner with Strategic Retail Advisors in Newport Beach, California.

Multifamily

The Orange County apartment market is one of extremes. It is one of the tightest markets in the country with a vacancy rate of just 3 percent. It is also one of the most expensive in the country for renters, with average rents ranging from $1,188 for a one-bedroom to $1,983 for a three-bedroom unit. And rents are expected to increase by 6 to 7 percent this year.

These kinds of extremes have made the market an extremely good one for investors. Taking into account the additional factors of steady population growth, positive job growth and home prices that are beyond the means of many renters, it’s no surprise that Orange County will be one of the top markets for multifamily investment for the next decade. However, becoming the owner of a multifamily property in Orange County has become more difficult. The following are some of the factors impacting the investment market:

Lack of New Supply — Despite a vacancy rate ranging from 3 to 5 percent and annual rent growth of 6 to 7 percent, new construction of apartments has been very limited. Land pricing is currently so high that new apartment construction doesn’t make economic sense. Instead, land available for apartment development is being bought by residential developers, which are building condominiums rather than rental units.

Cap Rates — Cap rates are at historic lows driven by investor demand and the condo conversion trend. Investor interest in apartments remains strong, but, in some cases, cap rates of less than 5 percent are driving sale prices ever higher. The result of this combination of low cap rates and high sales prices is that properties are being sold at record prices, but fewer properties are being sold overall.

Interest rates — Interest rates have been steadily rising for the last 12 months. The 10- and 30-year Treasuries recently hit a 4-year high. As the yield or interest rate on the bonds increases, so do monthly loan payments. The prevailing view is that rates will be trending upwards not downwards. If investors have variable-rate loans, this may be a good time to convert to a fixed-rate loan.

This real estate market has largely been driven by historically low or “cheap money.” As rates rise, buyers will be less able to afford the prices sellers are asking. In 2005, the number of transactions for apartments building exceeding 20 units was half the historical norm. This may be another year of low transaction volume and record prices.

— Roger Kinoshita is a senior associate in Grubb & Ellis Company’s Anaheim, California, office.

Office

A diverse economy, educated labor force and extensive international trade have combined to create strong economic growth in Orange County, resulting in a historically healthy office market. No longer considered a suburb of Los Angeles, Orange County is all grown up and on the radar of many institutional investors and developers due to its strong fundamentals and enviable statistics.

Direct office vacancy stood at approximately 7.9 percent at the end of the first quarter, down from 9.2 percent a year earlier. Adding sublease space, the availability rate is 10.4 percent. More impressively, the county’s average asking rental rate experienced its largest jump in a single quarter in the past 9 years, increasing by 5 percent to $2.39 per square foot. This new record high also represents the ninth consecutive quarter of positive rate growth and an approximately 12 percent increase from 1 year earlier. 

Consequently, large tenants have fewer options, and many are electing to renew leases in their current locations, usually at significant rent increases. Large-block tenants (40,000 square feet and up) can no longer expect their brokers to present them with numerous options when considering a move. Also, concessions continue to diminish in Orange County’s “landlord’s market.” With favorable trends in both vacancy and asking rates, Orange County has become one of the hottest national markets in which to develop or own office properties, keeping pace with Manhattan; Washington, D.C.; San Diego and South Florida.

The Irvine Company (IC) is always the office player with the most eyes on it. IC continues to “buy and boost,” acquiring core office properties (Newport Gateway and Irvine Center Towers this year) and pushing the rates dramatically. It also remains active on the development front as a major player in the approximately 4 million square feet of new office properties planned or under construction. IC has submitted plans for a sixth, and final, tower at Jamboree Center, and is underway on two new towers totaling 630,000 square feet in Spectrum.

Also in Irvine, Hines Interests LP has broken ground on a 260,000-square-foot tower on Michelson, and Opus West is close to commencing construction on a 300,000-square-foot building at its Opus Center complex. Maguire Properties continues its aggressive push into Orange County, currently awaiting planning approval on a more than 500,000-square-foot addition to its Park Place project. Maguire, which had focused exclusively on Los Angeles, has purchased 3.3 million square feet of core Orange County office product in the past 24 months. With increasing labor and material costs, the above new developments are expected to hit the market in 12 to 18 months with asking rates between $3.25 and $3.75 per square foot.

However, there has to be some cloudiness on the sunny horizon, right?  Mortgage companies that increased occupied space in Orange County tenfold in the past 5 years will continue to consolidate, shed jobs and put attractive sublease space on the market throughout 2006. Despite the apprehension and uncertainty that this may produce, most brokers, landlords and developers feel that other thriving industries in the healthy market will absorb this space. Orange County’s economy is expected to experience continued job and population growth, leading to healthy market conditions that should outpace most other California and national markets. 

— Steven Hogberg is vice president of leasing/sales for Coreland Companies in Tustin, California.

Industrial

The Orange County industrial market is enjoying demand from both owner/users and investors, which has driven sales prices to record highs. They have risen nearly 9 percent from a year ago, with an average asking price currently at $130.20 per square foot in first quarter 2006. Developers have been capitalizing on this demand by developing industrial projects with smaller buildings, targeted to owner/users at sales prices that have been able to absorb the escalation in construction costs and land prices.

The majority of the development activity is concentrated in North Orange County where underutilized sites are being developed into new for-sale, small building projects. North Orange County currently has eight new building projects under construction or recently completed. Another prevailing trend resulting from the increasing land and construction costs has been the acquisition of multi-tenant industrial parks and conversion to for-sale industrial condominiums.

Some of the most active industrial developers in the county are Guthrie Development Company, bkm Development Company, Burke Development Company, Panattoni Development and Koll Development Company. Some notable developments include Opus Development’s Anaheim Freeway Technology Park, which is a three-building distribution project totaling 430,000 square feet in Anaheim; Guthrie Development Company’s Freeway Crossroads, a 22-building, 139,542 square-foot project in Anaheim; Burke Development Company’s The Citrus, a 131,888-square-foot project consisting of 23 buildings in La Habra; and bkm Development Company’s North Anaheim Industrial Park, a 335,880-square-foot, 35-building industrial park on 20 acres of land in Anaheim.

Another byproduct of the strong industrial market has been a healthy resurgence in lease activity. The countywide industrial vacancy now hovers at an extremely low rate of 3.96 percent, creating a favorable environment for landlords. Manufacturing and distribution space is in strong demand, and landlords are taking advantage of the upward pressure on rents by granting fewer tenant concessions.

The average asking triple-net lease rate was 61 cents per square foot per month in first quarter 2006, an increase of 3.39 percent when compared to a year ago. Some of the significant lease transactions in Orange County include Bedrosians Tile, which signed a 5-year, $10 million lease on a 375,000-square-foot industrial building on East Winston Road in Anaheim; and Esselte Pendaflex, which signed a 10-year lease on a 218,000-square-foot industrial building, located at 6280 Artesia Blvd. in Buena Park.

— Michael Hefner is a senior vice president for Voit Commercial Brokerage in Anaheim, California.


©2006 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.