OC Office Market Overview
The Orange County office market showed signs of softening before the coronavirus pandemic, and the market metrics have deteriorated since the first lockdown back in March. Vacancy and availability rose substantially in Q4, gross absorption slowed further and net absorption remained in negative territory. Average asking lease rates were flat, but concessions continued to increase. The office product type has been harder hit by the pandemic protocols than its industrial counterpart due to higher employee density, multitenant, elevator-served buildings and the rise in the work-from-home strategy that has taken hold. Many businesses, forced into a remote work environment, are finding it to be less of a drag on efficiency than first thought. Office-based employees can remain productive by taking full advantage of the latest in communication technologies. That has business owners reevaluating their needs for space in the future, and that could put even more pressure on vacancy and absorption in the future. To be sure, these are uncertain times for the office product type, especially Class A mid- and high-rise buildings that have been most impacted by social distancing regulations.
Vacancy & Availability
The overall vacancy rate in Orange County rose to 12.45%, up 111 basis points in Q4. While this was not unexpected, it is significant and the trend may be accelerating. The Airport Area submarket has been hit hardest, due to its high concentration of mid-rise and high-rise Class A buildings. Vacancy in the Airport area hit 15% in the final quarter of 2020. By contrast, North County has fared best with a vacancy rate of just 7.84%, which, in part, reflects the fact that the inventory is skewed toward low-rise Class B and C buildings. Central County vacancy held steady at 12.77%. Looking at vacancy by building class is more revealing. Vacancy in Class A is up to 15.94%, compared with the Class B rate of 10.56% and just 4.46% for Class C space. The availability rate, which includes vacant and occupied space offered for lease, is rising even faster. Countywide 17.11% of the office inventory is on the market. In the Airport Area that rate rose to 20.67%. This indicates an increase in available sublease space and fewer renewals by tenants nearing the end of their lease terms.
The average asking lease rate for all office space countywide held steady in Q4, falling only a penny in the period to $2.80. It is common for landlords to hold the line on asking rates for as long as possible and offer more concessions like free rent and higher tenant improvement allowances when tenant demand softens. This widens the gap to effective rates which are more difficult to track. Concessions are definitely on the rise, as landlords look to get their vacant space leased up as quickly as possible to mitigate future rental income loss. They are also looking at competing with less expensive sublease space offered by larger tenants looking to downsize due to new occupancy strategies. A good example of this is the law firm of Rutan & Tucker that moved out of 206,000 SF on Anton in Costa Mesa into 51,000 SF at the Boardwalk project in Irvine.
Transaction volume fell in Q4 after a rise in Q3. In all, 386 transactions were inked during the period — 283 of them were leases and another 103 were sales. The number of leases fell from 369 in Q3, but sales transactions were up slightly from 92 in same period. This quarter last year recorded 525 combined leases and sales. Near-term uncertainty has caused a rise in short-term, in-place lease renewals rather than moves, and many of these transactions do not make it into the quarterly statistics. Tenants continue to take a defensive posture due to the uncertainty caused by the pandemic, which has clearly impacted new transaction activity. Many of them are reevaluating their occupancy strategies after being forced into switching to a work-from-home platform or an abbreviated in-office schedule that has worked better than expected for many office-using companies.
The unemployment rate in Orange County was 6.4% in November 2020, down from a revised 7.3% in October 2020, and above the year-ago estimate of 2.6%. This compares with an unadjusted unemployment rate of 7.9% for California and 6.4% for the nation during the same period. Other sectors with year-over-year declines included: professional and business services (down 13,800 jobs); government (down 13,300 jobs); educational and health services (down 11,300 jobs); other services (down 8,800 jobs); financial activities (down 5,400 jobs); and information (down 4,200 jobs).
Construction activity in the Orange County Office Market has been declining in recent quarters, which given the slowdown in transaction activity, will help the office market return to equilibrium more quickly. A little more than 1 MSF of office space was in the construction queue as the year ended. Fortunately, the bulk of that space is being developed by the Irvine Company. Its dominant presence as the county’s largest property owner gives it the ability to manage a slow leasing market better than other local developers. The two projects they have underway are low-rise campuses in the Irvine Spectrum submarket. The other speculative project is The Press, a 380,000 SF creative office project being built on the former LA Times property. Vans is also nearing completion of its 91,000 SF headquarters in Costa Mesa. Another 2.3 MSF of office space is in the planning stages, but we expect those projects to be on the back burner until the market changes direction.
Lower new transaction volume and an increase in short-term renewals added more downward pressure on net absorption in 2020’s final quarter. Net absorption, which measures the net difference in total occupied space, continued in negative territory in Q4. The net loss was nearly 1.4 MSF, double the Q3 decline. That brought total negative absorption for the year to just less than 3 MSF, a level the market hasn’t seen since the last recession. Over half the net loss in the Orange County Office Market came from the Airport Area, which has 37% of the county’s inventory and the highest concentration of Class A space, hit hardest by the virus shutdown protocols. Gross absorption, which measures total move-ins, managed to increase in Q4 by 312,000 SF to 1,688,000 SF. However, a significant portion of those deals were driven by tenants who were downsizing.
ORANGE COUNTY OFFICE MARKET FORECAST:
Given the fact that the year ended with additional pandemic restrictions on business activity, current market trends are expected to continue well into 2021. The Orange County office market has been hit particularly hard due to the labor intensity of office-using businesses. We expect negative absorption to continue, as expansion plans are put on hold and business owners take a harder look at how much space they will need when their current leases expire. Fortunately, the construction pipeline is drying up, which means those tenants on the hunt for space will be forced to choose from existing inventory to fulfill their requirements. Landlords will continue to offer incentives to increase occupancy in their projects, which means more free rent and an increase in tenant improvement allowances going forward. Class B and Class C buildings may be the beneficiaries as tenants look to reduce occupancy costs and decentralize operations to adjust to a new work environment that may be here to stay. Technology was already reshaping the workplace before the pandemic hit, and the pace of that change is likely to accelerate throughout the coming year.
For more information on the OC office space market and how to capitalize on real estate opportunities to grow your business, contact Stefan Rogers 949.263.5362 / email@example.com at Voit.