One Banting, the two-story, 70,000-square-foot office at Irvine Spectrum, is currently undergoing a renovation.

Orange County, California, is undergoing significant changes that will alter the future landscape and dynamics of its commercial real estate market. Unquenchable demand has sparked a transformation in the area from low-density suburbia to pockets of high-density urbanization. In addition, the investment market has been a driving force in Orange County, based on the global outpouring of capital from traditional equity markets into real estate. These factors will ultimately affect not only the commercial real estate industry but, on a broader scale, how and where people live, work and find recreation.

Where does one invest in Orange County? The answer is everywhere. The entire county is ripe with commercial real estate investment opportunities. Beyond the dot-com crash, low interest rates and the wave of recent corporate scandals have driven capital traditionally earmarked for the stock market into the realm of commercial real estate. Private and institutional investors such as individual entrepreneurs, pension funds and real estate investment trusts continue to blanket Orange County’s five commercial real estate submarkets in search of all product types, whether industrial, retail, office or multifamily.

The challenge in today’s market is finding available product. The shortage of inventory, coupled with 1031 exchange requirements, is creating an extreme imbalance in supply and demand, driving property values to unprecedented highs. Cap rates are lower than normal considering today’s soft lease rates and economic uncertainty. For instance, pricing for industrial product that would have sold for $50 per square foot 3 or 4 years ago, now sells for more than $100 per square foot with cap rates registering at less than 8 percent. With these unusual market dynamics, there are multiple offers behind almost every building for sale.

Investors who were planning to hold property for another 4 to 5 years are re-evaluating their approaches and liquidating their assets now while the market remains prime for sellers. For instance, San Francisco-based M&H Realty Partners, which invests in neighborhood and community shopping centers throughout California, currently has 35 centers on the market totaling more than $1 billion.

The hot investment market also has served as a catalyst for the redevelopment of south Orange County’s oldest retail centers, located along the El Toro Road Corridor in Lake Forest. The 30-year-old centers are on leased land, which previously made the viability of redevelopment less attractive to the retail developers because their ground leases could have expired before they realized the return on investment from the project. Recognizing both the need for redevelopment and the strength of the investment market, landowners now partner with the centers’ developers to help realize the assets’ full potential.

Originally built in 1971 by Alexander Haagen, the 275,000-square-foot Saddleback Valley Plaza will undergo a major renovation by Westrust Retail Centers in spring 2004 that will transform it into a regional center, to be renamed Orchard at Saddleback. The developer plans to reposition the project from a mom-and-pop, non-anchored center to a retail destination with national promotional retailers that better serve the expanding south Orange County trade area.

— Bob Hoyt and Cameron Crowner are vice presidents at Colliers Seeley International’s Irvine office.

Retail and Multifamily

Orange County’s retail market has felt little or no repercussion from the national economic slump. Demand for quality product continues to drive up lease rates and suppress vacancy rates across the county. In the second quarter, the average asking lease rate for non-anchored retail space rose to $1.83, 10 cents higher than the average rent just a year ago. A total of 158,000 existing square feet of space was absorbed in the Orange County retail sector in the first half of the year, dropping the vacancy rates to less than 6 percent.

As developers continue to build master-planned communities in south Orange County cities such as San Clemente, Foothill Ranch, Rancho Santa Margarita and Ladera Ranch, neighborhood and community shopping centers will spring up to serve the residents in those cities. In fact, this segment of the retail market outperforms the larger entertainment-themed centers that are more challenging to maintain in a soft economy.

In south Orange County, residential developers like Rancho Mission Viejo Company and Shea Homes partner with retail developers like Orange County-based Westar Associates and Pacific Development Group to provide residents in these new, upscale neighborhoods a well-planned, complementary package of homes and retail centers.

Further north in the more established, denser communities like Santa Ana, Huntington Beach and Anaheim, the new retail product coming on line is revolutionary for a suburban mecca like Orange County. Known for its suburban sprawl, parts of the county will soon be expanding vertically rather than horizontally.

At Jamboree Road near the 405 Freeway, Irvine’s first high-density housing development, The Marquee Park Place, will take root. The two-tower, 18-story, 232-unit luxury condominium complex, developed by Irvine Residential Highrise LLC, will not only add a new dimension to a city known for its master-planned communities but it also will help alleviate the area’s housing shortage while attracting the high-end retailers that tend to gravitate to more urban environments. Health clubs, theaters and restaurants are natural components to this type of urban setting.

Nexus Development has plans to build high-rise condominiums in Santa Ana’s Hutton Centre, which will be renamed MacArthur Place at South Coast Metro. The property is located just north of Irvine off the 55 Freeway. The Santa Ana-based company plans to construct a condominium tower and loft project to be accompanied by ground-floor retail shops and restaurant pads. The amenities will serve both office employees during the day and the onsite and surrounding residential customers during the evening and weekends.

— Cameron Crowner is a vice president at Colliers Seeley International’s Irvine office.

Office

Compared with past performance, the Orange County office leasing market remains soft though still healthier than the office markets in Los Angeles and Silicon Valley, which have relied more heavily on the tech industry in the past. Orange County’s broad-based economy has kept it somewhat insulated from any singular downturn like what was experienced in the dot-com world. In 2003, Orange County began showing signs of a recovery with positive net absorption numbers for the last four consecutive quarters. Most of this absorption occurred in the John Wayne Airport area, where 45 percent of the county’s office product is located.

Job growth in the office sector has improved partly due to increasing confidence as a result of the end of the war in Iraq as well as the addition of new jobs to support the booming Orange County residential building and mortgage industry. In the 12-month period ending June 2003, the county added 5,300 office-related jobs amounting to a 1.3 percent growth rate.

With few new construction projects and sublease space slowly diminishing, Orange County will begin to see further positive net absorption in the office market and a leveling of supply and demand. In the second quarter, 601,000 square feet of space came on line with only 246,000 square feet of new office space due to be built.

In the meantime, businesses are taking advantage of the weaker office market by upgrading their facilities from Class B to Class A space where lease rates have decreased. Other businesses are renewing leases early to take advantage of significant savings in rental rates and occupancy costs. Asking lease rates are down 10 percent from early 2002. Rates for Class A product average $2.26 per square foot, down from $2.53 per square foot a year ago.

Landlord concessions have increased again for larger credit-worthy tenants. In addition to free rent, landlords are offering to pay off the remaining portion of unfinished leases as an incentive for an early move into a new building.

— John Wadsworth is a vice president at Colliers Seeley International in Irvine.

Industrial

Throughout Orange County, the small industrial building sales market continues to surpass the leasing market for product under 50,000 square feet. The low cost of capital enables business owners to buy their buildings in order to contain their long-term occupancy costs. Cities in south Orange County are hotbeds for new construction based primarily on two things: the availability of land and the desire for business owners to live closer to home.

An example of this demand is the absorption at Rancho Business Center in Lake Forest located in the heart of south Orange County’s new residential construction. Eleven of the first 17 buildings were sold prior to completion. To date, that represents the highest total number of pre-sale commitments prior to building completion.

Over the last 24 months, industrial leasing activity fell sharply as interest rates dropped to record lows. However, the leasing market has seen signs of recovery. In the second quarter of 2003, lease rates climbed slightly by 1 cent per square foot, and Orange County experienced positive absorption for the first time in eight quarters, a trend expected to continue in the third quarter.

With lease rates bottoming out, industrial users desiring to stay in leased buildings larger than 50,000 square feet have begun to renegotiate their contracts 12 to 18 months prior to the end of their leases to leverage their position in the market. Because it takes building owners 9 to 18 months to re-lease a building of that size, both parties are amenable to an early negotiation to secure a longer-term lease sooner. For example, Fortune 150 company Behr Process Corporation, with 6 months left on it lease, recently renegotiated its 5-year contract on its 150,000-square-foot distribution center in Santa Ana.

Heritage Fields, the approximately 3,700-acre former Marine Corps Air Station, El Toro, in Orange County, will be sold through an online auction this fall. Situated in the middle of one of the county’s wealthiest and most prestigious areas, the land is to be annexed by the city of Irvine. The former Marine station will be sold in 4 parcels which may be allocated as 3,460 residential units, 3.1 million square feet of office, research and development, and retail space, 1,350 acres of parks, a 45-hole golf course, a college campus and an auto expansion.

— Kevin Turner and Patrick Remolacio are senior vice presidents at Colliers Seeley International’s Irvine and Anaheim offices.


©2003 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.