Marcus & Millichap compiles research monthly for Western Real Estate Business. This month, the research runs concurrent with our Market Highlights section, and additional information on each market can be found in the Western Markets Summary. Contributing to this section are John Przybyla, regional manager of Marcus & Millichap’s Newport Beach, California, office; and Brian Abernethy, a senior analyst who covers the Southern California real estate markets.

ORANGE COUNTY, CALIFORNIA

Retail

Retail properties have fared well in Orange County, as healthy consumer spending levels have kept most local retailers operating in the black. Low mortgage rates have spurred large amounts of refinancing activity among homeowners and produced a sizable amount of disposable income. Even though 3,000 jobs were lost in the region over the last year, retail sales have grown by 3 percent on a year-over-year basis to $34.9 billion. This generous amount of consumer spending has kept demand for space at a healthy level.

The vacancy rate for neighborhood and community shopping centers has moved very little over the past year and is currently a low 4.1 percent. This has allowed owners to keep pushing rents, which have risen by 4 percent over the last year to $2.06 per square foot.

Much of this rent growth is coming from central Orange County, where properties have the county’s lowest average vacancy rate at 2.5 percent. This densely populated section of the county has plenty of need for retail, and tenants competing for space are pushing up asking rents at an aggressive rate. Asking rents in this submarket are currently $1.86 per square foot, an increase of 5 percent from a year ago. Even rents in the pricey coastal market are still on the rise, just at a more moderate rate. Coastal property asking rents rose by 3.2 percent to $2.57 per square foot.

These rent increases, along with robust consumer spending, have kept investors interested in the county’s retail properties. Low lending rates also have played a major factor in the local investment market, helping to propel average prices upward at an aggressive rate. Strip shopping centers, which are the most active retail product type being sold, currently have a median price of $156 per square foot, an increase of 12 percent compared to 2002. Overall, the median price for all shopping centers has increased by 8.5 percent to $153 per square foot and the cap rate has declined from 9 to 7.9 percent.

Multifamily

Buoyed by a solid economy, the Orange County apartment market is continuing to show an impressive performance. Job growth is slowing, but has done little to counteract the demand for rental housing in the county. Single-family home prices continue to escalate beyond the reach of most renters, providing an amplified need for apartments. Developers have been unable to fill this need, as rising acquisition and development costs, coupled with a lack of developable land, deter construction. Projects that do come to fruition continue catering to higher-income tenants, with luxury apartment complexes accounting for the majority of activity.

There was a rise in vacant space during first part of 2002, but this was short-lived and was the result of job losses in late 2001 and early 2002. The average vacancy rate peaked in the second quarter of 2002 at 4.7 percent, when numerous Class A units hit the market and vacancies for this property class peaked at 7.4 percent. The average vacancy rate for all properties has since shown slight improvement, with the current rate at 4 percent. The highest vacancy rates are in Irvine, Newport Beach and Aliso Viejo, with vacancies ranging from 7 to 8 percent.

The tightest areas remain the central and northern submarkets, where vacancies remain below 4 percent. These two areas also have the slowest rent growth, as many owners in these submarkets prefer occupancy over rental growth. Central submarket rents grew by 3.9 percent to $1,105, while northern submarket rents increased by 3.5 percent to $1,080 per month during the 12-month period that ended in June. All told, the county is still achieving gains, with an overall increase of 3.2 percent to $1,232 per month.

Healthy market conditions, coupled with low interest rates, have kept numerous investors interested in the market and they continue to outnumber sellers. Despite the increased competition causing prices to skyrocket, buyers are willing to take the lower rates of return in exchange for solid, long-term growth. The current median price of $106,000 per unit is up 12 percent from what was achieved last year and the cap rate has declined in 2003 to 6.6 percent from 7.3 percent at year-end 2002.

Office

The weak office market is bottoming out, with gradual recovery expected over the next year. While the local office market remains statistically weaker than it was during its heyday in the late 1990s, stabilization is starting to occur. Vacancy rates have leveled out over the last year at a rate well above what is considered healthy for the market. The current vacancy rate of 16.7 percent is nearly identical to the rate 1 year ago, but is almost double the 8.7 percent vacancy rate achieved in 2001.

As expected, the hardest hit areas include the airport and south Orange County submarkets, where the majority of construction has taken place. Both of these submarkets have vacancy rates near 18 percent. Class B and Class C properties have started showing improvement in these areas, though, seeing average vacancy rates decline from 18 percent in early 2002 to the current rate of 14.5 percent.

The central part of the county remains the strongest, with vacancy rates averaging nearly 13 percent. With the economy weakened and the job market still posting negative numbers at mid-year 2003, few tenants are looking for space. Owners have been forced to compete with each other and offer aggressive concessions, which include free rent and generous tenant improvement allowances. These concessions have resulted in the average effective rent dropping by nearly 8 percent to $1.65 per square foot. While the rate of decline in both asking and effective rents has been slowing over the past year, the damage has been done.

All submarkets and property classes have been affected in the past couple of years, with Class A properties in the airport and south Orange County submarkets experiencing the worst declines. Asking rents for properties in the Airport area have declined to $2.46 per square foot, with south Orange County properties dropping to $2.25 per square foot. These rents have fallen approximately 10 percent from a year ago and are now down to 1998 levels.

The weakened market, however, has not deterred investors. The median price per square foot for all office buildings rose a healthy 6 percent during 2002, to $120 per square foot. While early results for 2003 show minimal upward movement of only 2.5 percent, to $123, the average cap rate continues to show a downward trend. The average cap rate was 9.4 percent in 2002 and has declined even more in early 2003, to 8.3 percent.

Industrial

Industrial properties in Orange County are still performing well when compared to other national markets, but the weak economy has eased demand for space. The county currently has approximately 9,000 less manufacturing jobs than a year ago and 6,000 less wholesale trade and transportation jobs. Most of this loss occurred in the latter half of 2002 and directly impacted industrial properties in the region. The vacancy rate, including sublease space, increased to 8 percent at year-end 2002 from 6.3 percent the year prior.

The market is starting to stabilize in 2003, with manufacturing down just 800 jobs since the beginning of the year. Most large-scale tenants — those seeking space in excess of 50,000 square feet — have disappeared from the leasing market, but plenty of demand still exists for smaller spaces. This demand, along with the stabilizing job market, has helped improve absorption of space to 900,000 square feet during the first half of 2003. The vacancy rate posted a 50 basis point improvement during this period, declining to 7.5 percent.

Despite the improvement in occupancy, rental rates have shown no gains since the end of 2002. The current monthly rate of 58 cents per square foot is identical to what was posted during fourth quarter 2002. This has not deterred investors, however, with prices achieving healthy gains over the previous year. Not including properties that have been purchased by the tenant, the median price for industrial buildings has increased by 23 percent to $105 per square foot. Investors are aggressively chasing deals that come to market, as evidenced by the average cap rate declining by 40 basis points to 7.9 percent.

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