MARKET HIGHLIGHT, NOVEMBER 2009

ORANGE COUNTY
Pat Swanson, Maurice Nieman, Jeff Morgan and Ian Britton

Already in a significant period of economic adjustment, Orange County’s commercial real estate sectors await the next wave with hopes that it will push them closer to solid ground.

Multifamily

The declining job market continues to take a toll on the Orange County multifamily sector. With unemployment reaching 9.6 percent in August 2009, the market is showing little signs of life. Relief will not come until new jobs are created and the unemployment level begins to descend.

Orange County’s apartment vacancy increased 36 percent during the 12 months following second quarter 2008, from 4.5 to 6.1 percent. Asking rents fell 1.9 percent since second quarter 2008, from $1,566 to $1,537, while effective rents during the same time frame decreased at a higher rate of 3.6 percent from $1,519 to $1,465. Despite the downturn in rental rates, tenants are vacating the apartment market in search of less expensive housing. Orange County residents are moving in with their parents, taking in roommates or seeking respite in neighboring markets or even out of state.

Rising vacancies have led to a decline in values by more than 20 percent since 2007. According to Costar’s year-to-date numbers, the average price per unit for buildings with 16 or more units is $129,704 with average cap rates at 7.83 percent, compared to 2007 when the average price per unit was $179,260 with average cap rates at 4.43 percent. Lower values and higher cap rates present an opportunity for private investors, but most are holding out in anticipation of more bank-owned commercial properties hitting the market.

With investors sitting on the sidelines, the Orange County market will remain flat through the end of 2009. High vacancy linked to the county’s staggering unemployment rate is a major contributing factor. Apartment rents historically trail the improving job market by 16 to 18 months. Not until well after unemployment shows signs of recovery will the multifamily market begin to rebound.

— Pat Swanson is a vice president in Colliers International’s Irvine, California, office.

Retail

The retail sector continues to struggle as consumer confidence remains relatively low. Until the job market begins to rebound, Orange County residents will maintain low levels of spending. This nervous sentiment has crossed over to prospective investors in retail properties because of the potential for weak cash flow.

Leasing activity is at a virtual standstill, with no anticipated movement for at least the next 6 to 9 months. With the exception of Kohl’s and Forever 21 leasing up former Mervyn’s’ stores and Marshalls taking up large space at previously occupied locations, most of the vacated big box spaces are sitting empty. As of August 2009, the Orange County vacancy rate increased to 7.7 percent, up 8 percent from the previous quarter. Further evidence of a weak market, the average asking rent declined $0.05 to $2.56 per square foot from the previous quarter.

Sales activity during third quarter 2009 has lacked large trendsetting transactions. Due to rising vacancies and declining rental rates, potential investors have been hesitant to acquire large properties, explaining why most of the deals have been small or mid-sized. Cap rates have shifted from 5 percent during the market peak in 2007 to 8 percent or higher for large, national credit tenants. Today’s investors are seeking quick-to-close, all-cash deals, although they are still holding out for better bargains. Once more bank-owned properties enter the market, competition could arise among investors.

The retail sector will remain soft until the unemployment rate improves, allowing consumer spending to increase. This will make retail properties more attractive to investors. On a positive note, not a lot of distressed assets have entered the market, financing options are still available and the hospitality sector has seen an up-tick in the number of advanced bookings. This all bodes well for Orange County retail.

— Maurice Nieman is a vice president in Colliers International’s Irvine office.

Office

Third quarter 2009 market statistics can be viewed as a foreshadowing of what is still to come in the Orange County office market. With absorption continuing its 2-year-long decline and an increasing number of high-profile assets being marketed for sale, the next 12 months will see a resetting of prices both in terms of asset value and lease rates throughout the market.

One point that just about everyone agrees on is that the office market has not yet hit the bottom on pricing. Once acquisitions of some of the prominent office buildings are final —the 337,000-square-foot former Downey Financial building in Newport Beach, California, being one of the most high-profile pending sales currently in the market — the new ownerships, largely private equity buyers in today’s market, will begin to recalibrate lease rates at these properties based on the current asset value, which will create a ripple effect throughout the market.

The other dominant factor looming in the market is the wave of debt maturing in the next 12 to 24 months. As this debt matures, many more properties are expected to be brought to market, which will continue the process of price resetting.

As of third quarter, the total office vacancy rate, which includes both vacant direct space and vacant sublease space, in Orange County was 17.2 percent, with the greater John Wayne Airport area registering the highest of the county’s five submarkets at 18.8 percent. Across the county, net absorption for the quarter was negative 523,771 square feet, bringing the year-to-date total to approximately 1.6 million square feet. A significant portion of the negative absorption in the third quarter can be attributed to the aforementioned Downey building, as U.S. Bancorp, which took over Downey Financial, closed operations in the building, vacating approximately 250,000 square feet.

The average asking lease rate for Orange County office space stands at $2.25 per square foot, a more than 13 percent decline from $2.60 a year ago. The greater airport submarket declined to $2.39 from $2.81 a year ago, but still maintains its position being the submarket with the highest asking lease rates in the county.

— Jeff Morgan is a senior vice president in CB Richard Ellis’ Newport Beach office.

Industrial

The Orange County industrial market continues to suffer from the effects of the national recession — widespread job losses, corporate downsizing, a lack of liquidity and an overall resetting of property values.

Local businesses are postponing capital expenditures, reducing workforces and attempting to shed excess space, which has caused the availability rate for industrial product to increase by 70 percent since first quarter 2009. While overall activity has increased during the past 60 days as a result of aggressive price reductions by owners, more space continues to come onto the market than is being leased or sold. North Orange County has experienced seven consecutive quarters of negative net absorption. The vacancy rate is just shy of 6 percent while the availability rate is approaching 11 percent.

The sharp increase in availability coupled with an overall lack of demand has created a tenant’s market where landlords are forced to be creative and are offering substantial rate reductions, free rent and moving allowances to entice tenants. Despite the aggressive attempts by landlords to lure tenants to their vacant buildings, many tenants do not have the confidence in their businesses to justify a large-scale move and are working with their existing landlords to complete short-term renewals. Although asking lease rates haven’t moved much given the lack of velocity and tenant demand, recently completed deals show that lease rates are down 25 to 30 percent from their 2007 peak.

As available capital has dried up, both investment and user sales have slowed considerably, and property values are down an average of 25 to 35 percent from their 2007 peak. Many of the recently completed small building projects, including The Reserve Brea, Valencia Business Center in Fullerton and The Citrus in La Habra, have recently reduced pricing by as much as 30 percent in an attempt to pull a limited pool of buyers off the sidelines.

The lagging effect of job losses will continue to negatively impact lease rates, and vacancy rates should rise through the balance of the year. Our industry may not experience the full impact of these losses for another 18 to 24 months as many distressed assets have yet to enter the mix. Owners will need to get creative with both tenants and buyers in order for overall activity to improve. Lease/option transactions, installment sales and short-term leases are going to become more prevalent as Orange County’s industrial sector works toward recovery.

— Ian Britton is a first vice president in CB Richard Ellis’ Anaheim, California, office.

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