MARKET HIGHLIGHT, NOVEMBER 2005

ORANGE COUNTY: THE APPLE OF MANY PEOPLE'S EYES
Rob Mitchell, Mike Hefner, Alex Pavich and John Beaney

Land in demand sums up the Orange County commercial real estate market right now. Employers want to expand their companies and thus desire new space. Tenants want to be in a great location with affluent demographics and/or close proximity to ports and other major markets. And, of course, investors want to have a stake in all of this.

Office

The continued strength of the Orange County office market is consistently tied to the region's outstanding job market. Unemployment for the second quarter was 3.3 percent, 0.8 percent below the previous year, and the county is forecasted to add 24,000 new jobs in 2005. These key variables are expected to contribute to Orange County's strong office market in the future as employers continue to seek valuable office space.

Available space represents one of the key concerns among Orange County employers. According to Voit Commercial Brokerage, the total amount of space available, including both direct and sublease space, currently stands at 11.15 percent, down from 14.55 percent in the previous year. The Orange County office market's vacancy rate currently stands at 8.93 percent, representing a steep decline of about 2.75 percentage points over a 1-year period.

The rapidly falling vacancy rates have led to strong upward pressure on average asking lease rates, which currently stand at $2.19 per month per foot, a 9 percent increase over the second quarter of 2004's rate of $2.01 per square foot. This represents the sixth consecutive quarter of positive lease rate growth as it continues to inch closer to the record-high average asking lease rate of $2.26 from first quarter 2001.

The shrinking availability of office space throughout the county, coupled with the sky-high lease rates has led to a slew of new construction activities. Total space under construction reached 1.5 million square feet during second quarter 2005, a whopping four times more than the previous year. Of the 76 office properties currently under construction, 42 are 10,000 square feet or smaller.

One of the key trends among new construction projects is the propensity for high-rise office buildings. With some of the county's hottest submarkets, such as the John Wayne Airport area and South Orange County rapidly running out of space, developers are now opting to build vertically. One such developer, Caribou Industries, is currently planning to construct Orange County's tallest building in downtown Santa Ana. The 37-story office tower, called One Broadway Plaza, was recently approved and is expected to break ground in 2006.

The forecast for the remainder of 2005 into 2006 points toward continued expansion and rising lease rates. As Orange County's economy continues to improve, lease rates are expected to increase at moderate levels, with concessions continuing to lessen. As these conditions continue to put pressure on lease rates, they should grow at a rate of 10 to 15 percent in 2005.

— Rob Mitchell is a senior vice president for Voit Commercial Brokerage in Anaheim, California.

Industrial

With sale prices continuing to increase and leasing activity robust, the Orange County industrial market is extremely strong. A number of emerging trends and new developments are playing a key role in strengthening — and altering — the industrial landscape of Orange County.

There are several trends currently at play within the market, beginning with the demand for smaller industrial product. Orange County is currently experiencing both the development of small buildings for sale to owner-users and the condominium conversion of existing multi-tenant industrial parks into owner-user for-sale product.

A second notable trend is the acquisition of industrial product by residential developers for re-entitlement as high-density residential and mixed-use commercial projects. This is most prevalent within Anaheim's Platinum Triangle, a high-density, mixed-use development that will bring the city an estimated 9,175 residential units and 5 million square feet of office space, with more than 2 million square feet of commercial uses. Other cities are now following suit, providing flexible zoning for mixed-use development opportunities in blighted or low-density industrial areas.

While 2004 was dominated by the sale of industrial product, 2005 has witnessed a strong resurgence in leasing activity. With the county now experiencing a vacancy rate of 4.33 percent, a 1.33 percent point decrease from 1 year ago, lease rates are expected to continue their ascent. The current triple-net lease rate of 61 cents per square foot per month represents a 15 percent increase over the previous year and marks the fifth consecutive quarter of positive lease rate growth.

The average asking selling price rate is $120.66 per-square-foot, an increase of almost 27 percent from 2004.

Despite the shrinking availability of industrial space, several key developers are active in the Orange County market, including Guthrie Development Company, bkm Development Company and Panattoni Development Company. There is currently 800,000 square feet under development, a marked increase from the 300,000 square feet that was under development 1 year ago.

One of the county's most extensive projects is the North Anaheim Industrial Park, which is under development as a joint venture between bkm Development Company and deRegt Development Company. The 390,000-square-foot park will encompass 35 planned buildings on 20 acres of land, with the first phase slated for completion in first quarter 2006.

As Orange County continues to experience strong investment activity across all of its submarkets, the remainder of 2005 through early 2006 is expected to yield similar results, accompanied by stable sale prices among virtually every product type and a steady increase in lease rates.

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

Multifamily

This year, Orange County's population topped 3 million. Offering unbeatable weather, a beautiful coastline and one of the lowest unemployment rates in the country, this Southern California county is absorbing residents from across the country. Add to that a virtual non-existence of developable land in the area, and high-density housing becomes essential in accommodating Orange County's growing population.

Many cities in Orange County have already begun revising general plans to meet zoning changes for urban infill construction. As a result, the county's suburban environment will see a shift towards urban living, as cities across the county start to model the live/work communities of popular urban areas.

According to the Building Industry Association, developers are organizing infill or urban focus groups within their companies to jump-start this new wave of infill construction. Companies including Bosa Development, Opus West, Nexus Development and Lennar are leading the development of area infill projects with a new expertise in high-rise construction.

As these high-rise infill projects emerge countywide, a new skyline will take shape in Orange County. For example, two 18-story towers and two 14-story towers at Central Park West will soon dominate the northwest corner of Jamboree Road and Michelson Drive in Irvine. Currently under construction by Lennar, the mixed-use development will span 42 acres and will include 1,380 urban-style residences, a 2.2-acre central park, a central park clubhouse, a four-story office building and 19,700 square feet of neighborhood retail space.

Although infill construction seems to be the new focal point in Orange County, existing apartment buildings continue to trade hands. Recent apartment sales include a 50-unit apartment complex in Garden Grove. Built in 1964, the Class B apartments sold in August for approximately $167,000 per unit. That same month the 59-unit Villa Mesa Apartments, also built in 1964, sold in Costa Mesa for $184,915 per unit. Since 2001, apartment units have almost doubled in price to an average $162,253 per unit with no signs of restraint.

To a much greater degree, sky-high home prices have presented even bigger challenges for Orange County residents. According to a survey performed by the U.S. Census Bureau last year, the median price for homes in Orange County was $512,208, while the median household income in Orange County was $64,416. Priced out of home ownership, renters are plentiful and apartment owners are taking advantage. On average, renters are paying a monthly premium of $1,370 to reside in Orange County, where apartment vacancies remain low at approximately 3 percent.

Rising home prices will continue to drive the rental market through the remainder of 2005 and well into 2006, while population growth will prompt further high-density housing construction. Conversion of apartments to condominiums may provide some relief for those priced out of ownership, though conversion could create a new problem — a shortage of rental units — for tenants, triggering an even greater elevation in rents at traditional apartment complexes. Revitalization of Class B and C apartments will be the inevitable next step in affordable housing for Orange County residents.

—Alex Pavich is a senior advisor in Sperry Van Ness' Irvine, California, office.

Retail

What happens when a geographic retail market maintains a record-low unemployment rate (3.8 percent) with affluent demographics and a dense population? You get one of the strongest and most resilient retail markets in the country: Orange County, California.

While the rest of the country was in a recession, Orange County continued to see high consumer spending and a healthy employment rate. Whether it is the job opportunity, the gorgeous beaches or The OC making it happen, the demand for retail is substantial and retailers across the country know it. Most retailers that journey into Orange County experience positive returns and those not yet included are itching to share the wealth.

When retail demand is high and availability for space is limited, inevitably the natural result is that rents push upward. Currently, the countywide retail vacancy rate is at a low 3.8 percent causing the current average monthly rent to climb to $2.40 per square foot, second only to the San Francisco Bay area, and this rate is only expected to increase. With land prices at historically high levels, the steep land acquisition costs translate into higher rents for retailers. However, retailers' insatiable desire to locate in Orange County outweighs the high price they will pay to be in the market, with the thoughts that strong sales will more than pay for the location itself.

The high demand, low availability trend is also obvious in the investment arena, where there are clearly more buyers than product. REITs are making their mark by acquiring smaller portfolios, making upgrades and improvements over time, and raising rents as tenants transition out of spaces. Major developers currently active in the market include The Irvine Company, Vestar Development Company, Regency Centers and JH Snyder, which are all developing in or around the Orange County region.                    

Centers having strong per-square-foot performance — South Coast Plaza, Fashion Island and Tustin Marketplace — will experience intense competition with new retail centers currently under development and poised to impact the Orange County retail scene.

In Tustin, Vestar Development Company purchased a prime parcel of land to develop the 1 million-square-foot outdoor center: The District at Tustin Legacy. The project broke ground in March and completion is slated for spring 2006. The project will strategically integrate a unique mix of power center anchors, promotional, specialty and lifestyle retailers blended with a variety of restaurants and entertainment venues. Vestar has successfully developed similar projects in Phoenix and is bringing their award-winning concept to Orange County.

Further south, in Irvine, the continued expansion of the Irvine Spectrum Center will follow the new tenant-mix trend. In addition to the entertainment, specialty and restaurant tenants already located at the center, Nordstroms and Target will debut at the center this fall.

In the midst of a major redevelopment is one of the most underutilized and best-located retail projects in Orange County, the former Huntington Center Mall. The oldest enclosed mall in Southern California will re-open shortly as Bella Terra. JH Snyder bought the property in 2001 and has since redesigned it to be an upscale open-air lifestyle oriented center. Kohl's has been operating a location at Bella Terra since 2003. Other tenants that will join the lineup include Cost Plus, Bed Bath & Beyond, REI, ULTA Cosmetics and California Pizza Kitchen, among others.

A controversial retail project in South Orange County, The Promenade at San Clemente, is also finally underway. Due to its oceanfront location, the developer, Craig Realty Group, went through a 10-year approval process with the Coastal Commission. The Promenade at San Clemente will be Orange County's first outlet center. It will also feature residential, restaurants and, possibly, an entertainment component, according to Wally Limburg of Strategic Retail Advisors, who is representing the developer in its leasing efforts for the project.

With all of the exciting projects coming online and demand booming, retail in Orange County should continue to blossom, boast healthy numbers and remain at the top of the retail charts and retailers' location wish list.

— John Beaney is a senior vice president for Colliers Seeley International in Irvine, California.


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