MARKET HIGHLIGHT, NOVEMBER 2007

ORANGE COUNTY
Linda Barden, Doug Killian, Louis Tomaselli and  John Beaney 

The struggles in the single-family sector are being felt in Orange County, but no one can argue with the market’s strong fundamentals, as seen by the low vacancies and strong development activity.

Multifamily

Despite financing challenges and a lack of available land, Orange County remains one of the strongest multifamily markets in the nation with high demand, active developers and strong economic fundamentals. An increase in tenant demand, fueled by high home prices, has caused twice as many multifamily building permits to be issued in comparison to the once-popular, single-family residential permits. From January 2007 to June 2007, there were 2,200 multifamily units permitted, with Orange County already boasting 5,575 multifamily properties totaling 103,443 units.

Average multifamily rents in Orange County remain high at $1.70 per square foot, making multifamily properties the dominant force in terms of demand and development. With the high cost of land in Orange County, multifamily developers are now looking to build vertically. While high-rise multifamily properties are a new concept in Orange County, “building up” allows developers to capitalize on land use and increase density.

Anaheim’s Platinum Triangle project is an example of vertical construction. The approximately 829-acre mixed-use development by Nexus Properties, BRE Properties Inc., Archstone Communities, KB Urban and West Millennium Homes will include up to 9,000 high-density, urban residences.

In addition, Irvine is another key submarket for major developers, such as John Laing Homes and Jamboree Housing Corporation, because of the city’s bustling retail sector and strong employment market. Several notable projects in Irvine include Jamboree Housing Corporation’s Granite Court Apartment Homes, a four-story, 71-unit development, and Wood Partners’ Alta Pacific, a 132-unit apartment complex. Both projects are scheduled for completion in 2008.

Due to high land prices and tighter development standards, South Orange County and Newport Beach are not experiencing as much development as the cities located within the heart of the market.

Financing also remains a challenge in the Orange County multifamily market. With the uncertain future of interest rates, underwriters and lenders are tightening loan criteria for financing transactions. Demand remains high with cap rates gradually edging upward above 5 percent. During September 2006, cap rates hovered in the mid- to high 4 percent range, making bridging the gap between buyer and seller a formidable challenge.

Despite the challenges, there are many strong fundamentals guiding the Orange County multifamily market, such as a low vacancy rate ranging from 3.5 to 4 percent. The county also has enjoyed a low unemployment rate, very strong job growth and a diverse job base. These strong economic fundamentals continue to make Orange County an attractive market for investors, which are enjoying continuous rent growth — between 5 and 6 percent — as well as high occupancy levels.

In 2008, Orange County’s multifamily market will exhibit similar characteristics as it has during 2007. When current financing challenges balance themselves through the course of 2008, formerly active investors will begin to step off the sidelines and become dominant players once again. Based on the fundamentals, Orange County should continue its path in 2008 as one of the strongest performing markets in the nation.

— Linda Barden is a senior associate on Colliers International’s Private Capital Advisors Multifamily team in Irvine, California.

Office

The Orange County office market is currently in the midst of a transitional phase. With vacancy rates increasing due the meltdown in the mortgage industry and the new product coming online, a number of challenges exist. However, Orange County still has very strong economic fundamentals and an appetite for continued development.

Orange County currently has more than 2.2 million square feet of office space under development, the vast majority of which is occurring in the John Wayne Airport and Irvine Spectrum submarkets. The city of Irvine remains the most sought after location for new development, accounting for slightly more than two-thirds of new construction in the county at 1.65 million square feet.

Overall leasing activity is falling short of original projections. Meanwhile, the reeling mortgage industry has returned a substantial amount of space back to the market. The end result is a current vacancy rate of more than 10 percent. As the final 2007 Class A towers are delivered to market, the county will see a double-digit vacancy increase, virtually unthinkable 1 year ago. As a result, landlords may offer concessions such as rent abatement, relocation funds, increased tenant improvement allowances and reduced parking fees to help absorb the growing inventory of vacant space.

Despite the growing likelihood of concessions, Orange County landlords remain optimistic based on a number of variables and are not expected to lower lease rates, which recently posted their 15th consecutive quarter of positive growth. The area’s strong local economy and high quality of life continue to make it a desirable location for business. Orange County also consistently posts one of the nation’s lowest unemployment rates, which most recently was 4.2 percent. The continued increase in employment opportunities should help to ease vacancy rates throughout 2008.

Several new, state-of-the-art Class A properties are also expected to garner a great deal of enthusiasm. The Irvine Company recently completed construction on 18100 Von Karman, a 10-story, 231,178-square-foot office tower. The firm is also developing 20·40 Pacifica, two 15-story travertine-clad towers in the heart of the Irvine Spectrum that are slated for completion in fourth quarter 2007.

Additionally, Hines and Crescent recently completed construction on 2211 Michelson, a 12-story, 266,000-square-foot office tower in Irvine, while Maguire Properties recently completed its 20-story, 530,380-square-foot office building at 3161 Michelson in Irvine.

2008 will be a rebound year in the Orange County office market. While a host of challenges abound, the county’s strong economic foundation, desirable location and state-of-the-art new product should help push vacancy rates downward. The growing influence of new industries, such as high technology, biotechnology and healthcare, should further diversify the local economy and help to rejuvenate the office market.

— Doug Killian is senior vice president of Voit Commercial Brokerage’s Irvine, California, office.

Industrial

With 344,826 square feet of positive absorption thus far in 2007, Orange County remains an attractive market for industrial development. The shrinking availability of land is only allowing the development of primarily small, for-sale industrial buildings. This lack of available land, coupled with the high land prices, has lead to few mid-size buildings and distribution centers being developed in this infill market.

Several of Orange County’s most active developers include Guthrie Development Company, Lowe Enterprises, Panattoni Development Company, The Koll Company, The Magellan Group and Burke Development Company. These developers are developing numerous projects throughout the county. Several notable projects include Guthrie Development’s Guthrie Lambert Business Center, a 28-building, master-planned business park totaling 132,642 square feet situated on 7.92 acres in Brea, California; The Koll Company’s Koll Center 3, a 188,374-square-foot flex-technology complex comprising 56 buildings located within Irvine Spectrum in Irvine, California; and Lowe Enterprise’s Kimberly Business Center, a two-phase industrial park totaling 274,720 square feet in Fullerton, Calif.

Despite a lack of available land and increasing construction costs, there is still more than 1 million square feet under construction.

Already saturated areas in North Orange County boast some of the lowest vacancies in the county, coming in at 2.77 percent during second quarter 2007. This is a record low for the northern submarket, which contains 47 percent of all industrial buildings in Orange County. Overall, industrial vacancy measured in at a low rate of 3.84 percent, which is 1.05 percent lower than 2006.

Despite a low level of development activity, Orange County remains a strong investment market as well. Some of Orange County’s key investors include First Industrial Realty Trust, Sares-Regis Group, BPG Properties, Greenlaw Partners, ProLogis, TA Associates Realty, ING Clarion and RREEF. The CMBS market, to date, has not affected the investment market in terms of availability or pricing. Demand for investment remains high with aggressive pricing and cap rates averaging 5.5 percent for Class A industrial buildings, 6.5 percent for Class C industrial buildings and 6 percent for midrange Class B buildings.

One of the primary factors for the ongoing strong investment market is demand. Twenty-year historically low vacancy rates have meant lease rates have continued escalating due to a rise in demand. In 2005, there was an 11 percent increase in rates, a 12 percent raise in 2006 and approximately another 12 percent climb so far in 2007.

Looking ahead to 2008, the industrial market will exhibit many similar characteristics as it has in 2007. Limited opportunities for new development will open with land and sales prices remaining high. Multi-tenant, flex, distribution and R&D buildings will not undergo development, as no large land parcels will become available. Industrial buildings for both sale and lease will remain viable options for those looking to enter the Orange County industrial market.

— Louis J. Tomaselli is senior vice president of Voit Commercial Brokerage’s Anaheim Metro office.

Retail

With a number of new developments underway and several, high-profile national retailers entering the market, Orange County is one of the nation’s most desirable retail markets in the country. Despite recent challenges within the mortgage market, Orange County’s strong economic fundamentals and diverse population should help it maintain its strength throughout 2008.

One of the key new developments within the Orange County retail market has been the arrival of H&M, a Swedish retailer that has been highly successful on the East Coast and has recently opened stores in Irvine Spectrum and South Coast Plaza.

While there are a number of successful shopping centers in Orange County, such as Irvine Spectrum, South Coast Plaza and Fashion Island, a number of new retail projects are underway, which should further lure national tenants to the market. One of the key differentiating aspects of these new projects is the advent of the mixed-use concept. Ten years ago, multi-level mixed-use projects were unheard of in Orange County, but are now becoming a staple among new developments, particularly in Anaheim.

Excel Realty is currently developing the Anaheim GardenWalk, a three-level mixed-use project featuring traditional retailers, in addition to hotels and restaurants. Meanwhile, the Platinum Triangle, an 870-acre mixed-use project being developed by Lennar, will be designed to attract visitors from nearby Honda Center, Anaheim Stadium and Disneyland. The project will include ground-level restaurants and retailers, with multi-level residential units above the retailers.

In addition to the Platinum Triangle, Lennar is also undertaking the redevelopment of the Tustin Marine Base and the long-term redevelopment of El Toro Marine Base, making the firm one of the most active developers in Orange County. As the single largest landowner in Orange County, The Irvine Company remains one of the County’s most influential retail developers, with its neighborhood centers being developed throughout South Orange County.

South Orange County is a difficult area for retailers to penetrate due to the extensive amount of master-planned communities, which limit retail and commercial developments. Communities from Irvine to San Clemente are experiencing a greater demand for retail developments, more so than the current product can supply. Another retail challenge in the market: Lease rates throughout the county remain high, making it difficult for many retailers to achieve desired revenues. Additionally, the crisis in the mortgage industry has had a substantial effect on many heavily residential communities in South Orange County, such as Ladera Ranch and Laguna Niguel, potentially creating a difficult market for retailers.

Despite these challenges, Orange County remains one of Southern California’s most dynamic retail markets and is a highly desirable location for national retailers. As new projects begin to come online in 2008, the future remains very bright for a flourishing retail market.

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

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