WESTERN SNAPSHOT, MARCH 2009

Orange County Office Market

After 2 successive years of negative net absorption, the Orange County office leasing and investment sectors are looking for some positive news in 2009. The leasing market should continue to decline, while the investment market will continue to feel the impact of the global recession, with signs of improvement by the fourth quarter.

Tenants are definitely in control in the Orange County office leasing market. Although the year-end 2008 vacancy was up only a few percentage points year-over-year (11.1 percent to 13.4 percent), the differential during the 24-month period is staggering (up from 7.1 percent). Adding in shadow space that is not actively on the market, the vacancy rate would approach 20 percent. Given this increase in supply, current asking rents for Class A properties are $31.73 per square foot, full service gross, for high rise space, compared to $35.08 a year ago. Naturally, part and parcel to this decrease in pricing is negative net absorption of approximately 1.5 million square feet in 2008. Obviously, when presented with a credit-worthy tenant, landlords are quick to offer concessions in order to attract quality occupiers of space.

Even with the downturn in overall occupancy, Orange County tenants continue to move laterally within the market to occupy vacant space. Those include Memorial Health Care, Hyundai Motor Finance, Kofax Inc., and, most recently, FDIC occupying more than 200,000 square feet in Irvine Spectrum. The FDIC transaction could lead to additional space leased by the government and service providers to accommodate the oversight and resolution of troubled assets.

From an investment sales perspective, 2008 was an equally challenging year, though one should expect improvement by fourth quarter 2009. Sales volume declined by approximately 80 percent compared to $6.9 billion in 2007. This was largely a result of the global economic crisis, particularly illiquidity in the real estate capital markets.

Values have decreased up to 30 percent since the peak in 2007, with a healthy bid-to-ask spread for most assets and many investors sitting on the sidelines. Lack of financing, higher vacancy and lower rental rates have all contributed to higher capitalization rates and declining values. Completing larger transactions generally requires stabilized occupancy and strong credit, whether a long-term corporate sale-leaseback or a multi-tenant property with a well capitalized buyer and seller with realistic expectations. Value-add opportunities are very difficult to finance, further reducing activity.

While investment sales activity and values may decrease further in 2009, anticipate a shift in the fourth quarter, with marked improvement by third quarter 2010. This will be driven by several factors including: more than $300 billion of U.S. commercial mortgage maturities, corporate sale-leaseback activity, allocations for distressed property and note acquisitions, and economic recovery fueling liquidity in the real estate capital markets.

Leland Bruce and Grant Freeman are senior managing director and managing director of corporate capital markets, respectively, at Jones Lang LaSalle’s Irvine, California, office.

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