If you want to buy or rent space in the Orange County Office Market you’ll be facing higher rents and sale prices by the end of 2018

MARKET OVERVIEW:

The Orange County office market grew at a healthy pace in the third quarter, responding to strength in the economy as employers continue to expand. While the growth is stronger than it has been in nearly a decade, the office market is by no means — the pace of expansion is still considerably slower than in past times of economic growth. One factor holding the office sector back is that employers have been packing more employees into less space, doing away with private offices and designing smaller cubicles. With that said, Orange County continues to be among the most dynamic submarkets in the country. Business sectors including finance, technology and consulting services should help maintain stability in the market.

Vacancy Rates:

The vacancy rate for Orange County office buildings slightly rose in 3Q 2018, as newly completed office space for lease came onto the market. The vacancy rate in the Orange County office market sits at 11.83%. This is up from 11.34% in 2Q, and up from 9.97% last year. The large amount of new supply that came online coincided with many tenants desiring to reduce their footprint. Expect vacancy to trend downward in 2019, based on steady job growth and consumer confidence, coupled with many tenants currently in the market shopping for space.

Lease Rates:

The average asking full-service gross (FSG) lease rate per month per square foot in the Orange County office market was $2.72 at the end of 3Q, a 3.82% increase from this time last year and a $0.05 increase from 2Q. The highest rates were in the Airport Area Class A buildings, where rental rates averaged $3.08. Anticipate asking rental rates in Orange County to continue to modestly rise throughout 2018 based on the strong level of current demand from a variety of industries.

Transaction Activity:

The fundamental demand driver is a strong local and regional economy. The employment base has been buoyed by various financial and business services, legal, and healthcare firms. This provides stability that was not present during the recent past. In 3Q 2018, 1.92 MSF of total transactions (sale and lease) were recorded, up from just over 1.62 MSF in 2Q. The healthy level of activity during the first two quarters of 2018 offers a reminder that the Orange County office market remains on solid footing. Demand is healthy for Class A product and major employers continue to strategically grow.

Economy:

The unemployment rate in Orange County was 3.1% in August 2018, down slightly from a revised 3.2% in July 2018, and below the year-ago estimate of 3.8%. This compares with an unadjusted unemployment rate of 4.3% for California and 3.9% for the nation during the same period. Educational and health services reported the largest overall increase with a gain of 3,100 jobs. Healthcare and social assistance added 1,800 jobs while educational services expanded by 1,300 jobs. Professional and business services gained 5,300 payroll jobs over the year. Sixty percent of the gain

Construction:

Total space under construction checked in at 688,545 square feet at the end of 3Q 2018 with the most notable being Lincoln Property’s Flight @ Tustin Legacy, a spec project that is expected to start delivering at the beginning of 2019. In Irvine, the redevelopment of the former warehouse at 2722 Michelson should wrap up by the start of next year, with 155,000 square feet of new space, already committed to by Anduril, and Spectrum Terrace Phase 1, 116,261 square feet, an ultra-modern campus nestled on 73 acres of open space in the heart of SoCal’s innovation hub.

Absorption:

A growing number of successful companies are strategically downsizing to save money, improve collaboration, and boost productivity. During the balance of 2018, expect demand for office space to remain steady due to new hiring demands offset by implementation of more efficient layouts. Today’s tenants are more concerned with efficiency, so businesses attempt to put more people into less space. Net absorption for the Orange County office market was negative 375,816 square feet in 3Q, bringing the 2018 annual total to a negative 1,122,991 square feet.

COMMENTARY:

It is safe to say if you want to buy or rent office space in Orange County you will be facing higher rents and sale prices at the end of 2018. The Orange County economy is continuing to be one of the fastest growing in the nation and the Orange County office market continues to improve. Asking rental rates and sale prices have increased over the past two to three years. Although hard to find, good investment opportunities still exist if one knows where to look. 2018 has been a strong year for office property investments, with solid property fundamentals, low interest rates, and ample supply of capital. Most investors that are buying properties are also investing a lot of capital into the properties after they close escrow.

Although Orange County office market vacancy rate statistics themselves may not suggest supply shortages, a growing scarcity of available large blocks of quality office space and continued rent increases makes for more speculative development in certain parts of Orange County. There are fewer than 20 properties (existing or under construction) with a block of 100,000 square feet for lease. Tenants looking for 50,000 square feet have 48 different buildings from which to choose. Between now and year-end 2019, developers are expected to deliver a total of 1.0 million square feet. The market vacancy rate should finish 2018 at 11.40% and will fall 4 percentage points to 10.90% by year end 2019. On an annualized basis through 2017 and 2018, asking rents are anticipated to increase by 4%, to finish 3Q 2019 at $2.83.

Institutional investors continue to target Orange County, regularly trading properties and office campuses. However, assets with Class B or higher are the most commonly sold inventory, often among private investors and institutions. Average cap rates have settled in to the 5-6% range, more than 150 basis points higher than in the apartment sector.

The Orange County office market is expected to continue its upward trend through 2018, with supply constraints and conversions from industrial to other property types playing key roles in tightening Orange County’s fundamentals. Vacancies are low, demand is consistently strong, and it’s still a landlord’s market. Tenants looking for industrial space face one of the tightest markets in the country, as growth in traditional import logistics and e-commerce continues to drive strong demand. This consistent demand and a lack of quality space have pushed asking rents higher. The Orange County industrial market continues to benefit from the rise of e-commerce as retailers strive to respond quickly to demand throughout Orange County.

Strong market fundamentals and a diverse tenant base make Orange County one of the nation’s most attractive destinations for investors, developers, and businesses. Expect to see rents continue to climb as older buildings get brought back to life and office owners find creative ways to offer their tenants more amenities.

FORECAST:
Lease Rates:

Expect an overall modest increase in pricing in the coming quarters. We expect the average asking lease rates to increase by 3% over the next year. Steady demand for office space is pushing up rents at class A buildings in all Orange County cities. Rents for Class A office space in Orange County are forecast to rise 3% this year, to $3.20 square feet.

Vacancy Rates:

Across the Orange County office market, net absorption was negative in 3Q, increasing the overall vacancy rate. Tenants
continued to downsize their space, while other industries like business services, nonprofits, and coworking companies have increased demand for space. With the availability of existing office space declining, we expect the vacancy rate to drop to 11% by year end.

Overall:

While new construction tends to be a top choice for tenants, many are leaving behind more space than they are taking. Office space availability, combined with new construction that recently came to market, has left some tenants with multiple options while others have struggled to find the right space. Availability is expected to slightly increase throughout the remainder of the year as the ongoing trend toward right-sizing continues to put a damper on net growth.

For more information on the Orange County office space market and how to capitalize on real estate opportunities to grow your business, contact Stefan Rogers 949.263.5362 / srogers@voitco.com.

Click HERE to download Voit’s Q3 2018 Orange County Office Market Report.