MARKET HIGHLIGHT, JUNE 2007

ORANGE COUNTY’S BOUNTY
Chris Migliori, Joe Winkelmann, Linda Barden, Barry Knudson and John Beaney

Demand for real estate in Orange County is so strong that the residential slowdown and related sub-prime lending struggles won’t amount to much of a speed bump. The multifamily sector is benefiting from the housing downturn while competition for industrial, office and retail space remains fierce.

Industrial

It is a unique era in the Orange County commercial real estate market. Vacancies are at historical lows, industrial lease rates are on the rise and unemployment rates remain low as Orange County’s businesses remain highly profitable. Meanwhile sub-prime lenders are filing for bankruptcy and residential developers are now offering buyer incentives.

As a result of these strong fundamentals, there are many institutional and individual investors on the sidelines attempting to buy into the market at cap rates between 5.75 and 6.50 percent.

The Orange County industrial market remains one of the tightest in the nation. The shrinking supply of available land has driven up prices, while new construction activity is on the decline and is unable to keep pace with demand. With vacancy rates remaining low, lease rates are on the rise, while sales prices remain strong.

The price of Orange County industrial land ranges from $30 to $50 per square foot. Meanwhile, with little available product on the market, it has become even more difficult to find buildings for sale with amenities such as excess parking, outside storage and clear height. Businesses are now looking to the for-lease market as it provides less frustration, more opportunities and an economically viable solution.

Despite rising lease rates, vacancy rates have continued to remain below 5 percent and finished first quarter 2007 at 3.2 percent. Orange County’s average asking lease rates for buildings between 10,000 and 40,000 square feet have risen by 19.4 percent during the past 18 months, and finished first quarter 2007 with an average monthly rate of $0.77 per square foot, triple-net. Of the five major submarkets in Orange County’s 10,000- to 40,000-square-foot industrial market, South County holds the highest average asking rent of $0.90 per square foot, triple-net, along with the highest vacancy of 4.5 percent. North County currently holds the lowest average asking rental rate at $0.65 per square foot, triple-net, and the West County submarket has the lowest total vacancy at 1.7 percent.

Net industrial absorption gained approximately 1.8 million square feet of occupied space during 2006, and finished first quarter 2007 with additional gains of approximately 495,000 square feet. Construction activity came in at 1.32 million square feet underway at the end of 2006 and has since declined to 1.1 million square feet at the end of the first quarter. Despite rising construction costs, the Orange County market continues to see a fair amount of new development activity, with the North County market currently holding the lion share of more than 486,000 square feet underway.

Since available land has become such a rare commodity, developers are now turning to small building industrial projects to cater to the growing demand for space among the region’s growing population of small, entrepreneurial firms. Smaller buildings for sale under 20,000 square feet are ranging from $180 to $205 per square foot.

Multi-tenant condominium conversions have also become the product type of choice among developers in Orange County, as they pose virtually no construction risk, little carry risk and most cities are embracing the developments.

Despite the diminishing supply of new product in the development pipeline, Overton Moore Properties and bkm Development Company have recently completed two major developments. Overton Moore Properties recently completed Pacific Gateway, an 830,000-square-foot development in Seal Beach offering six for-lease and three for-sale buildings. bkm Development Company finished phase one of the North Anaheim Industrial Park, a 168,050-square-foot industrial building. Phase two, an 119,226-square-foot project is slated for completion this month.

With demand continuing to increase despite the high price of land and diminishing supply of new projects, both lease rates and sales prices should remain strong throughout the remainder of 2007, while infill development and condominium conversions should set the tone for development for the foreseeable future.

— Chris Migliori is executive vice president/principal for DAUM Commercial Real Estate Services in Anaheim, California.

Office

Orange County is home to one of the most vibrant and resilient office markets in the country. The sector represents the leading product type in the area and serves as a key catalyst to the current success to Orange County’s commercial real estate market.

The office market witnessed a slight increase in vacancy, from 9.3 percent at the end of 2006 to 10.1 percent in first quarter 2007, due to new construction coming online and the sublease of office space as a result of the sub-prime mortgage fallout. The sector is moving forward in full force and slowly digesting the increased space on the market. Two-thirds of the office space that reentered the market from the mortgage bank tenants has been reabsorbed.

Although vacancy has increased slightly, Orange County has the lowest office vacancy rate in the country, and office rental rates continued to push upwards with a 10 percent increase in a 12-month period, going from $2.52 per square foot at the end of 2006 to $2.61 during first quarter 2007. Class A office properties are commanding an average of $3.03 per square foot, with trophy buildings pushing the $3.50 per-square-foot mark. This trend will continue throughout 2007. However, the new construction that is coming online should stabilize the asking rental rates by the end of the year.

The return to high-rise development is one of the strongest illustrations of Orange County’s healthy office market. Several high rise projects will come online in 2007, such as a 530,000-square-foot, 20-story office building being developed by Maguire Properties; Hines and Crescent Real Estate Equities’ 265,000-square-foot, 12-story office tower; and the 231,000-square-foot Irvine Towers, a 10-story building being developed by The Irvine Company, one of the major office players in the market.

The Irvine Company, Maguire Properties and Segerstrom are the dominant office landlords, comprising the majority of the office market activity taking place in Orange County.

The largest office submarket in Orange County is the area surrounding John Wayne Airport. This area is experiencing the most office activity in the county with 369,000 square feet of new construction completed during the first quarter and 3.8 million square feet under construction, half of which is pre-leased. As this space comes online the office base will expand by 5.2 percent.

Orange County’s strong market fundamentals will fuel a healthy office market in 2007, with strong job and population growth and office demand representing the key ingredients.

— Joe Winkelmann is a senior vice president in Colliers International’s Irvine, California, office.

Multifamily

The Orange County apartment market has been vigorous in 2007. While the housing market has taken a downturn, the apartment market continues to fare well, benefiting from the housing slump. Economic factors such as an active buyers market, increasing lease rates, lack of availability and rampant demand from both tenants and investors comprise a vibrant apartment market in Orange County.

On average, rental rates have increased 5 percent within the last year, a rate that typically ranges between 3 to 4 percent annually. One of the key factors contributing to the high increase is low affordability of single-family homes, which, in turn, has created high rental demand from tenants. The current Orange County occupancy rate is approximately 96 percent.

The Orange County housing sector was affected by the meltdown of the sub-prime lending market, which caused the region’s major lenders to file for bankruptcy. However, according to The USC Lusk Center for Real Estate, the resilient Orange County economy, with its strong job market, will experience a short-term adjustment, and the apartment sector will fare well as a result, with people opting to rent.

High rental demand from tenants has caused a spark in investor activity for Orange County apartments. Demand is coming from all sides of the investment arena, including private capital, institutional and developers looking for value-add opportunities. According to Real Capital Analytics, private investors purchased up to 65 percent of all apartment acquisitions through 2006.

While institutional investors and REITs have historically focused on apartment properties of 100 or more units, the strong lack of availability of large apartment communities is driving institutions and REITs to consider investing in smaller apartment projects as well. Two of the largest are pension fund CalSTRS and apartment REIT Avalon Bay Properties. In addition, Class C and D multifamily owners are disposing of their properties and looking to invest in Class A and B assets in order to take advantage of the more affluent renter demographic present in many Orange County submarkets.

The county’s coastal communities are rarely affected by market fluctuations because demand is always strong for the beach locations. Rental-heavy submarkets, such as Costa Mesa, encourage condo conversion projects. A lack of available land in Orange County has hindered new apartment development. Any new development is high-rise, residential condos or a repositioning of an existing property, with the exception of the Anaheim Platinum Triangle project, which is expected to bring up to 9,500 units to the market once completed.

The Orange County apartment market will remain strong in 2007, driven by a diverse economy with rental rates steadily increasing, high demand due to a lack of new and available product, a strong job market and continued population growth.

— Linda Barden and Barry Knudson are a multifamily team at Colliers International’s Private Capital Advisors in Irvine, California.

Retail

Orange County continues to be one of the most desirable retail markets in the country. Most retailers already located in the market want to expand their presence in order to capitalize on the disposable income, healthy job growth and dense population. However, this desire is challenged by lack of acceptable retail sites.

Several new projects that are in the development pipeline will give retailers an opportunity to expand their brands within the area. The District at Tustin Legacy is one of the largest retail projects to be built in Orange County in the past 10 years. The 1 million-square-foot open-air lifestyle and entertainment destination, under development by Vestar Development, will offer a blend of large promotional tenants, restaurants, specialty lifestyle retailers and a number of gathering spots for its guests, such as outdoor living rooms with fireplaces.

The Irvine Company, the largest landowner in the county, has several retail projects planned and under development, mostly to complement the new residential developments planned during the next 15 years. The new projects the firm is considering will be neighborhood centers featuring a grocery component, such as Orchard Hills in Irvine, which is under development and expected to come online in 2008.

Orange County’s relative lack of developable land has sparked a surge in redevelopment of existing, well-located projects that, for various reasons, have lost their intended functionalities. In the last few years, the former Mall of Orange has been “de-malled,” as was the former Huntington Center, now known as Bella Terra. Originally built in the 1970s, these centers became outdated and were redeveloped and updated to reflect the demands and retail needs of the sophisticated consumers that inhabit the county.

The most recent example of this trend is Westrust’s redevelopment of the former Saddleback Valley Plaza, a 15-acre, 250,000-square-foot center in El Toro. Renamed The Orchard, the redevelopment was conditioned upon the widening of El Toro Road, which upon completion triggered redevelopment on three corners of the intersection of El Toro and Rockfield in Lake Forest, California. The resulting development created several large and mid-sized box opportunities for retailers seeking to penetrate the highly desirable South Orange County area.

Another trend in the market is obsolete industrial properties being repositioned as retail space, particularly those with good freeway access and exposure. The former Nabisco facility in Buena Park, California, is to be demolished and replaced with a 250,000-square-foot retail property, of which 130,000 square feet will likely be occupied by a large format, home-improvement user.

Chevron Corporation’s former corporate facility on Imperial Highway in Brea, California, has also been demolished and is now under construction as a mixed-use development featuring high-end retail and loft residential units slated to open in 2008.

In central Orange County, the Anaheim Garden Walk, a multi-level retail project located adjacent to Disneyland, is slated to open in mid-2008. It will feature approximately 400,000 square feet of retail, directed at both the tourist and high-density local markets.

In summary, although Orange County is a fairly mature retail market, it will continue to prosper in 2007 with new redevelopment trends taking wind, creating more retail opportunities for merchants to prosper and for the Orange County residents to enjoy.

— John Beaney is senior vice president of Retail Tenant Services in Colliers International’s Irvine office.


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