Despite a national trend in which office rents are surging in reaction to frenzied transactional activity of the last two years, Orange County – even though it’s seen its share of office properties change hands – is a bit of an anomaly.
Historically low Orange County vacancy rates have begun creeping upward, just as we forecasted this time last year, and asking rents are edging higher, too, owing largely to so many high-profile acquisitions by deep-pocketed buyers and new premium office product being added to the inventory. But broad rent increases in Orange County are advancing only slightly overall and at roughly half the rate seen in the nation’s top office markets.
Additionally, there are signs that some Orange County landlords are feeling the pressure to lure tenants with concessions that serve to mask much lower effective lease rates. For example, it is rumored that one major landlord is offering such a generous tenant improvement allowance on one Class A building that it translates into the equivalent of 18 months of free rent on a five-year lease.As for asking rates, at the end of the second quarter Orange County office rents averaged $2.63 per square foot, a 1.5% increase from the first quarter. Nationally, asking rents jumped 3.1% in the second quarter in the 79 largest U.S. markets. That followed a 2.8% national first quarter gain.So it’s clear that for now Orange County is going its own way.
With so much new Class A office space recently completed and more expected soon, coupled with numerous sales of buildings at record prices, many landlords are challenged to generate even average returns. The overall vacancy rate has been rising, due to thousands of mortgage industry layoffs, slow job growth and the completion of new space that’s already come on-line. The Anaheim Stadium submarket in north central Orange County, which includes The City in Orange, is the county’s most troubled. The Class A vacancy rate is 16% on a base 3.17 million square feet in 22 buildings. Even if the pace of average annual net absorption of 200,000 square feet were to immediately resume, there’s enough inventory for three years. But with an abundance of small mortgage companies in this submarket there is a strong likelihood the vacancy rate in this submarket will continue to rise.Not all submarkets are the same. In Newport Center buildings command consistently higher than average rents and occupancy rates. At the end of the second quarter only 4.2% of Newport Center’s Class A space was available, and last year its rents began breaking the $5 per-square-foot barrier. Overall countywide there will be a significantly increased level of supply of Class A office that could prove to be a challenge to some landlords for several years.
Moreover, it’s clear that for owners who have paid upward of $400 per square foot for premium office buildings they will have difficulty producing satisfactory returns unless there is continued significant rent growth and healthy appreciation in value. In this regard, the outlook is questionable.