According to Q2 office reports from Marcus & Millichap (M&M), Orange County, San Diego, and the Inland Empire are all experiencing high demand, and few properties are on the market.
In Orange County, all types of buyers are targeting mid-5% cap rates targeted, and most of the deals are closing in the Irvine and Santa Ana markets, M&M reports. Private and institutional capital are both interested in these submarkets because of the wide variety of price points.
The fact that few properties are for sale is causing prices to rise, a trend that is likely to continue as current owners see soaring NOI growth, according to the firm. Buyers are looking into other markets for higher returns, including Tustin, Anaheim, and Garden Grove. In those cities, rental rates are rising as vacancy drops and development has been stagnant for several quarters.
For example, as SoCal Real Estate recently reported, representatives of Ware Malcomb reported that construction has been completed on a newly renovated office building located at 14201 Franklin Avenue in Tustin. The 40,000-square foot, two-story building had been vacant for years before being redeveloped by Long Beach, California–based Harbor Associates.
In the Inland Empire (IE), office employment has grown and vacancy is low, prompting owners to hold onto their properties, decreasing the number of available properties in the market and driving up prices while decreasing sales velocity. Buyers from nearby markets, particularly Los Angeles, are interested in the region due to its lower sales prices, which can be more than $100 per square foot, depending on the property, M&M says.
Properties ripe for redevelopment are leading sales activity in the eastern part of San Bernardino County, as well as the Ontario Airport Area, M&M reports. Buyers are eyeing class-B and -C properties that date back as far as the 1980s, which can generate cap rates as high as 7 percent. On the other hand, “newer vintage” office properties, which are available in the South Riverside submarket, can run more than $300 per square foot.
Construction has mellowed in the IE, and vacancy for class-A office is so low that landlords in this asset class are not motivated to list. M&M reports, “Over the past 12 months, no property that was built within the past 10 years has sold, limiting institutional investor activity.”
Meanwhile, the buyer pool for San Diego office properties is also growing deeper as institutional and regional investors look outside their market into this one for less-expensive assets, according to M&M. Few owners of high-quality properties are motivated to sell, yet demand is high, forcing many investors to seek low-vacancy class-B assets.
M&M reports, “Business park-heavy Carlsbad is a hot spot for buildings constructed within the past 20 years, while Sorrento Valley, Mission Valley, and UTC are targets for buyers eyeing 1970s- and 1980s-built assets.”
Landlords of class-B office in this market are seeing yields no lower than the low-5 percent range, the firm reports. Both San Diego–based and L.A.–based investors have been milling about the class-C market, looking to redevelop distressed and struggling office properties built before 1990, many of which are located near Downtown San Diego. These are properties that trade for less than $5 million at cap rates that exceed 6 percent.