ORANGE COUNTY
Kitty Wallace, Jeff Ingham, Brian Bennett, Wes Hunnicutt, Matt Moore and Terry Bortnick

Orange County’s multifamily and industrial sectors are showing positive signs, while the market’s strong fundamentals keep its investment appeal high across the board.

Multifamily

The Orange County multifamily market is the first local commercial real estate sector to emerge from the recent economic recession and subsequent burst of the real estate bubble. With occupancy rates on the rise, particularly in core cities, investors are once again strongly attracted to the sector. As prospective homeowners remain leery of the housing market, many have focused their attention on leasing apartments, which has helped the bottom line for multifamily landlords.

The vacancy rate stands at 5.4 percent, down from 5.9 percent in the previous quarter. This marked the first time since third quarter 2007 that two consecutive quarters posted vacancy declines. Along with the improvement in vacancy, rental rates are slowly increasing. The average effective monthly rent is $1,433 per unit, up from the $1,428 reported during the previous quarter. However, this is far from the peak of $1,509 reported in third quarter 2008. As fundamentals improve, landlords are starting to pull back the concessions they previously offered to prospective tenants.

Although development activity is not near the level it was at before the recession, there are some notable projects that were recently given the green light. AvalonBay Communities is planning a 179-unit complex to be constructed at the corner of Jamboree Road and Richter Avenue in Irvine. Also, Mill Creek Residential Trust LLC is planning two new developments in Irvine — one will contain 156 units and the other will have 194 units.

Multifamily investment activity in Orange County significantly increased in 2010 from the previous year. In 2010, there were 21 transactions of 50+ units for a total sales volume of almost $1.03 billion ($197,316 per unit). In 2009, there were only 10 multifamily properties with 50+ units sold for a total sales volume of more than $393.7 million ($144,760 per unit). The Irvine Company, Essex Property Trust, AvalonBay and Western National Group are several companies that made significant multifamily investments during the second half of 2010. In first quarter 2011, there’s been a decline in the number of large multifamily investments due to a lack of available supply. However, the transaction volume is forecast to increase as the year moves along since the first quarter is typically the quietest period of the year in commercial real estate. The market is also expecting to see vacancy and rental rates gradually improve during second quarter.

— Kitty Wallace is executive vice president for Colliers International in charge of the greater Los Angeles area.

Office

Beginning in late 2010, there was a pervasive sense of optimism entering the Orange County office market stemming from two consecutive quarters of positive net absorption totaling more than 500,000 square feet. However, this sense of optimism took a step back during first quarter 2011 when more than a dozen companies, led by the likes of FDIC and Wells Fargo Bank, announced layoffs that will affect more than 2,600 employees in the coming months.

Further, the FDIC’s closing of its approximately 200,000-square-foot operations in Orange County is expected to take several years to absorb into the South County area as the outlying submarkets rely on the core market, the Irvine Spectrum, to drive tenant demand. Currently, office vacancy at the Irvine Spectrum is 19.5 percent.

There has never been a better time for tenants to relocate. With vacancy at a historic high of 15.7 percent, compressed rental rates of $23.26 per square foot per year and large blocks of quality space available, it is an opportune time for tenants to upgrade their facilities and build out space to a new generational standard. Typically, when vacancies exceed 20 percent, market trends favor the “flight to quality,” an election by tenants to move to a higher quality space at a comparable or lower cost of occupancy. High vacancy rates of 19.9 percent in Class A product are continuing the flight to quality.

From a volume and pricing perspective, investment activity was strong at year-end 2010. The Irvine Company conducted strategic purchases, including Pacific Financial Plaza in Fashion Island and Pacific Arts Plaza adjacent to South Coast Plaza. While there have been no significant building sales in 2011 to date, 2600 Michelson (Irvine), 7700 Irvine Center Drive (Irvine Spectrum) and 4 Hutton Centre Drive (Santa Ana) are expected to close during the second quarter. Core assets with stabilized vacancy are trading at cap rates below 7.5 percent. Pricing is substantiated by buyers with a long-term view who can purchase at below replacement cost today and wait for increasing rental rates in future years.

Expect that 2011 will continue to be a rebuilding year with little rental-rate change and anomalies in the market, though there was some major news recently with the announcement that the Irvine Company is developing a 450,000-square-foot headquarters facility for PIMCO in Fashion Island, the first build-to-suit in many years.

— Jeff Ingham is senior managing director at Jones Lang LaSalle.

Industrial

The Orange County industrial market has shown promising signs of improvement and continuing positive momentum during first quarter 2011. An increase in tenant activity and a greater volume of deals in the marketplace are building confidence among landlords and developers.

Current forecasting indicates positive absorption for the Orange County industrial market in first quarter, which would mark the third consecutive quarter of positive absorption. By the end of 2011, industrial vacancy rates are expected to drop below 6 percent for the first time since 2009. With nominal properties currently under construction to put more pressure on vacancies, anticipate the trend of stabilization to continue.

The overall average asking rent for industrial space in Orange County hovers in the $0.50 per square foot per month range, which is in line with the average reported at the end of 2010. The market has yet to experience substantial rent growth. However, as positive absorption continues, landlords will begin to escalate rates and reduce concession packages. Recently completed deals are still seeing multiple months of free rent, tenant improvements and other concessions from landlords.

One trend that was common in late 2009 and the majority of 2010 was the “blend and extend” lease renewal or restructure. In the past 18 months, the main goal was to retain tenants and avoid future vacancy exposure. Landlords were willing to negotiate with existing tenants 18 to 30 months prior to a tenant’s scheduled lease expiration, in hopes of stabilizing assets and streamlining long-term revenues. With signs of improving market conditions, it appears the same landlords are much more bullish in their expectations and perception of market conditions. Most landlords are unwilling to negotiate with existing tenants if the lease is not expiring within the next 12 months.

As investors look for prudent investments, a minimal increase in the amount of sales activity is evident but, overall, the investment community remains relatively quiet. There is a substantial amount of capital on the sidelines making for a very competitive environment when quality assets come to market, which could have a positive increase in the amount of sales going forward, especially as lenders look to dispose of distressed assets. Although cap rates are not anticipated to experience a substantial gain, certain investors will still look to acquire quality assets, and qualified owner-users will take advantage of very competitive financing options.

Reflecting the common expectation for many quarters now, once employment rates drop and consumer confidence stabilizes, the Orange County industrial market will undoubtedly recover.

— Brian Bennett, Wes Hunnicutt and Matt Moore are principals at Newmark Knight Frank’s Irvine office.

Retail

National retailers are coming back to the Orange County market, but are being extremely selective in their choices for new locations. Since the scars are still fresh from 2008 and 2009, these tenants are making sure that “every box is checked” before they will complete a deal for a new site. Discount retailers that have had a long foothold in Southern California such as Ross, T.J. Maxx and Dollar Tree have been making deals, but they are negotiating very hard on just about every deal point.

The supply of larger retail spaces is now dwindling, which should allow landlords to negotiate from a stronger position. Among pad and in-line national tenants, the banks and fast-casual/quick-serve restaurants are willing to pay top dollar for the prime spots.

A trend that is far from slowing, the driving force in the market in the last year has been the local tenants, the seasoned and savvy operators that own small local chains typically ranging from 3 to 50 units. These local retailers can move quickly and are not saddled with the slow decision-making process of national and publicly traded companies.

Besides daily-needs offerings typically found in grocery-anchored centers, health-, family- and pet-oriented stores are the other profitable and expanding tenant types. Until job growth and the housing sector turn bullish, retail categories that are not catered towards the aforementioned needs will continue to suffer. An example can be seen in the high number of failures among dry cleaners and nail salons, uses that were typically bulletproof categories in neighborhood settings.

Given its population diversity, attractive climate and lifestyle options, Orange County continues to be a place where investors want to own retail properties — so much so that very little supply comes on the market. And when they do come on the market, they get snapped up, often at cap rates in the 6 to 7 percent range. With interest rates still historically low, single-tenant retail assets continue to provide great yield, safety and inflation protection when compared to traditional income investments. With local and state governments making investors increasingly nervous, a shift out of the municipal bond market into long-term, net-leased retail properties is a trend to watch.

There have been very few larger neighborhood and community centers that have come on the market recently. When they do, there is often a bidding war. Smaller, unanchored strips in lower- to middle-income areas are less appealing, especially if there is a lack of credit tenants.

— Terry Bortnick is the president of Argent Retail Advisors in Dana Point, Calif.

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