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MARKET HIGHLIGHT, JANUARY 2012
ORANGE COUNTY
Patrick L. Murphy, Chris Gentzkow, Mitch Zehner, Jared Dienstag and Alan X. Reay
Orange County’s commercial real estate market was far from recession-proof, but its prime location, educated workforce and high-quality offerings has made recovery much easier here than in most places. The region’s difficult single-family housing market has also been an added advantage, as it’s spurred multifamily activity.
OFFICE
Even as one of the most dynamic markets in Southern California, Orange County’s office market has had to cope with the same serious challenges that surrounding office markets faced. But this established market’s fundamental advantages — its coastal location, excellent transportation options, vast selection of Class A office product and attractive pricing (combined with an improving job outlook) — should help buoy this marketplace somewhat over the next 12 to 18 months.
The recovery and resulting correction will be at a steady creep, however, and not at the fast pace many real estate experts and owners would prefer. The recent trend of quarter-over-quarter positive absorption will be directly linked to job creation in the future. The majority of activity last year was in the airport submarket, which also commanded the highest prices. This year, a declining vacancy rate, when combined with the lack of new construction, should support a slightly improved outlook. At the close of last year, the overall market vacancy hovered near 18 percent. The first half of 2011 looked much more promising than the latter half, with its many starts and stops and bumps along the way. That may be the all too familiar office pattern again in early 2012.
For tenants, this slower sector correction and still attractive rents will make for great opportunities in this area in 2012. The competitive rental rates are not expected to tick up by much, but will probably stabilize after hitting bottom in select submarkets. They will offer a wide choice of options for relocating tenants. Concessions will remain generous to secure the best tenants in the market. Over the short term, the Orange County office outlook will remain a tenant’s market.
The average overall full-service gross (FSG) asking rent in Orange County during 2011 was $1.95, dropping from near $2 the previous year. The trend of Class B users jumping to attractively priced Class A product will continue in the first half of 2012. This effort to reduce expenses, while landing better operational locations, will still be very popular. Expect to see some tenants that were on the sidelines in 2011 now ready to make a move. These national and regional occupiers are sophisticated and will be looking for experts with the talent and expertise to focus on their specific needs and their unique corporate expansion requirements/considerations. However, even with slightly increased activity, the pace of demand will appear low by historical standards.
One of largest deals at year-end 2011 was by CoreLogic in Irvine, which leased 169,287 square feet that was previously occupied by the FDIC. Hyundai also leased 147,700 square feet; Western Digital completed a 104,000-square-foot expansion; and Mircrosemi locked in 109,984 square feet. On the sale side, Bella Terra, a 428,806-square-foot, mixed-use office/retail project in Huntington Beach, was purchased in a distressed transaction for $76 million by Lincoln Property Company.
— Patrick L. Murphy, managing principal, CresaPartners in Newport Beach
RETAIL
CBRE recently completed a comprehensive study on the state of big box vacancy in Orange County. It showed that while the county continues its struggle to replace large tenants lost during the recession, there is progress being made in this important sector of the retail market, particularly in Class A locations.
There are currently 59 big box vacancies (20,000 square feet or larger) in 55 centers with a total of 2.3 million square feet within the county. In the past two years, approximately 1.6 million square feet of big box retail has been absorbed. The question now is, what’s left and when will it be absorbed?
Since the downturn, retailers have had their pick of great real estate. Class A space that was near impossible to find in Orange County during the boom years became available for the first time. The most active retailers, including Wal-Mart, Kohls, grocers and gyms, moved quickly to take advantage of the opportunities. In many cases, these retailers even modified their prototypes in order to do so.
With most of the Class A space quickly absorbed, our study found that 48 of the 59 boxes currently remaining, or 84 percent, are located in B or C centers. We predict these B and C vacancies will continue to be a problem for landlords. In order to lease this space and reduce blight often caused by vacant big box space, these landlords will need to start looking at alternative uses.
There are many critics when it comes to the future of big box retailing. Retailers like Borders have gone out of business while others face growing uncertainty, fueled in part by Internet sales. Some claim the Internet has killed mass merchandisers, and that the ease and simplicity of Internet shopping will continue to put pressure on traditional retailers. Others believe bricks-and-mortar retailing is an ingrained part of modern society and an integral part of its future.
Regardless, both tenants and landlords will have to change and adapt to the new reality. Retailers must figure out a way to look beyond their typical prototype. They must alter their format to utilize the multi-channels of retail sales by integrating the Internet world with the physical store. They must find a way to relocate and reposition stores to take advantage of their best demographic. Landlords should seek these types of tenants and, if none exist, look beyond retail and seek alternative uses.
In a recent article in the Harvard Business Review, Ron Johnson, CEO of JC Penny and the man credited with inventing the Apple Store, said it best. “So it’s not department stores’ size or location or physical capabilities that are their problem. It’s their lack of imagination — about the products they carry, their store environments, the way they engage customers, how they embrace the digital future.”
— Chris Gentzkow, vice president, retail specialist, CB Richard Ellis’ Newport Beach office
INDUSTRIAL
With 95 percent occupancy, the Orange County industrial market is shining through the clouds of what is still a semi-lethargic market in many areas. It’s well known that industrial real estate is a solid investment option that is safer than many other investment vehicles. Combine that with Orange County’s reputation as a place that people love to work and live, and it’s no surprise the county’s industrial market is successfully rebounding.
Industrial buyers were not just cautious in 2008 and 2009, they were literally standing on the sidelines waiting for the game to resume. The trough of the market really hit in 2009, which was probably the lowest point anyone could have bought a building, but with values down 35 percent to 40 percent, deals just weren’t being made.
Since mid-2010, however, the Orange County industrial market has seen a significant increase in activity as buyers put themselves back in the game. Sellers have become sellers again, and buyers are more realistic about getting deals done. Corporate America recognized the trend early on and began making deals. From there, the competition has heated up on the Orange County industrial playing field, as numerous investors seek to acquire Class A and B industrial product.
A major reason for this activity is that investors and users recognize pricing is at its lowest point. It is most likely where it should be for Orange County industrial buildings. Buyers know owners are really listening to their brokers and pricing assets fairly, and they know now is the time to acquire higher-quality properties for less money.
Many users are taking advantage of this excellent pricing and making substantial deals in the region. In 2011, Voit directed the acquisition of a 292,080-square-foot distribution center in La Palma on behalf of the buyer, Dexus Acquirer LLC, which acquired the property for $18.3 million. In addition, TIAA-CREF, an owner-user, acquired the 300,000-square-foot Anaheim Concourse Distribution Center, a Class B distribution facility, for $30 million.
Another example of users taking advantage of an excellent value on an Orange County property is Amada America. This La Mirada-based company was looking to expand its operations and identified a high-quality, 185,741-square-foot facility in Brea, which it acquired for $16 million.
Examples like these are encouraging, and continue to fuel interest amongst investors and users alike.
While industrial sales are strong in Orange County, we will see more tenants recognize the competitive pricing in today’s market and make more deals as we move forward. We know lease rates will rise with job growth, but Orange County lease rates will most likely increase even more than anyone could expect due to a lack of inventory.
With little land remaining for development and most of the quality product over 100,000 square feet already snapped up by investors and owner/users alike, it will be leasing that will become the next major activity in the market.
— Mitch Zehner, executive vice president, Voit Real Estate Services’ Anaheim office
MULTIFAMILY
The multifamily market continues to be the strongest performing real estate market in Orange County. With the support of solid fundamentals and forecasts, investors are flocking to multifamily investments, especially properties located in core cities. As the for-sale residential market remains uncertain, much of the Orange County population is choosing to lease, which has been a big driver following the economic recession.
The vacancy rate stands at 4.5 percent, which accounts for a 20 basis point drop from the previous quarter’s rate of 4.7 percent and a 140 basis point decline from the 5.9 percent recorded one year earlier. This was the third consecutive quarter that witnessed a decline in vacancy. These rates haven’t been this low since the second quarter of 2008. Although vacancy has dropped considerably since it peaked at 6.4 percent during the third quarter of 2009 through the second quarter of 2010, it remains higher than the low point of 3.2 percent, which occurred in the third quarter of 2007.
Rental rates have also increased as vacancies have filled. The average effective monthly rent is $1,488, which represents a slight increase from the $1,478 recorded during the previous quarter and an even bigger increase from the $1,455 recorded one year ago. Despite the improvement, this is far from the peak of $1,528 recorded in the third quarter of 2008. During 2009 and 2010, landlords offered concessions like free rent to new tenants in order to entice them to sign leases. However, with the decline in vacancy, concessions have become severely limited in the marketplace.
Multifamily investment activity in Orange County was strong during 2011. In 2011, there were 18 transactions of 50+ units for a total sales volume of $766.5 million ($177,906 per unit). Avalon Bay Communities, Western National Group and Clarion Partners are several companies that made significant Orange County multifamily investments during the year. Although we have seen a slight decline in the total volume of large multifamily investments from 2010, it is not due to a lack of interest. Instead, it’s the result of a small supply of available core properties.
With market fundamentals improving, many landlords are electing to hold their properties unless they are blown away by an offer. However, sale prices are expected to increase in 2012 as vacancy rates continue to decline while rents remain on the rise. By far, the multifamily market has rebounded quicker than other property types since the recession.
— Jared Dienstag, regional research analyst, Colliers’ Irvine office
HOSPITALITY
The Orange County hotel market held up extremely well during the economic recession. We are now seeing average daily rate (ADR) and occupancy levels at or above the 2007 peaks.
The Smith Travel Research (STR) statistics through October 2011 show the county’s beach areas reporting a $164.41 ADR at 71.3 percent occupancy with a $117.25 revenue per available room (Rev PAR). The beach area’s Rev PAR is now just under 12 percent below the 2007 market peak. We forecast that we will be back to or above the peak levels in 2012.
In the Disneyland area, we see an ADR of $128.02 at 73.6 percent occupancy with a $94.22 Rev PAR. This Rev PAR is already 6.7 percent above the 2007 peak and climbing.
There are a number of reasons why we’re seeing such strong performance numbers in Orange County. These include:
(i) The increase in domestic travel, with many travelers choosing to stay in the United States instead of going abroad
(ii) The increase in international travel due to the relative weakness of the U.S. dollar, making Orange County a prime destination
(iii) The complete lack of new hotel development, which has created a growing demand that has helped fuel rate increases
Orange County’s strength is also why it’s managed to escape much of the distress we saw in other California markets. During the downturn, Orange County only had six hotels that were foreclosed on and only five that entered default. For comparison, Los Angeles County had 16 foreclosed hotels and 21 in default. San Diego County had 21 hotels foreclosed on and 16 in default.
Last year saw a huge rebound in California hotel sales, not just in Orange County. Orange County hotel owners have been reluctant to sell mostly due to the market’s continuing improvement and the relatively low level of distress.
The number of Orange County hotel sales fell 20 percent in 2011, with only four 100+ room properties sold. This was half the number of 100+ room sales that we saw in 2007. The median price per room for Orange County hotel sales jumped 31 percent in 2011, but as the median was still 22 percent below the 2007 peak, we predict that there is a lot more room for increase in 2012.
All in all, the outlook is very positive for Orange County hoteliers: strong economic fundamentals combined with very little new development equals robust price appreciation.
—Alan X. Reay, president, Atlas Hospitality Group in Irvine
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