The sale of City Tower in Orange, California, for over $147 million was the most notable first-quarter office sale in the market. | Courtesy KBS

Highs and Lows in the OC Office Market

Carrie Rossenfeld Finance & Capital Markets

Some Orange County office-market segments are showing strengthening trends, while others experienced a bit of softening in the first quarter, according to a report from Cushman & Wakefield (C&W).

Overall vacancy rose 50 basis points (bps) quarter-over-quarter to 11.6 percent, while the market reported marginal occupancy growth. Meanwhile the average asking rate continues to rise due to the addition of new class-A construction.

Eric Kenas, Cushman & Wakefield’s director of Research for Greater L.A. and Orange County, says, “The increase in vacancy is largely accredited to the major blocks of space yet to be occupied from the new construction completions in 2017 to present. Despite the uptick in vacancy, overall asking rents have increased $0.50 year-over-year, averaging $2.84 per square foot per month full service. Rental rates should continue their steady elevation at the hand of the high-end class-A development expected to be delivered the remainder of this year.”

While outperforming all other classes in terms of demand and occupancy, at 14.5 percent, class-A vacancy still remains far more elevated than its class-B and -C counterparts due to its advanced level of new construction, C&W reports. Class-B vacancy maintains single digits at 9.4 percent while the more inconsequential class-C market stood at a mere 2.2 percent vacancy rate.

Kenas adds that the Orange County office market occupancy did manage to finish in the black to kickoff 2018, with 53,000 square feet of positive net absorption. Fueled by occupancy in new development, Irvine Spectrum towered over all other submarkets with its more than 800,000 square feet of growth. However, a significant portion of that growth was single-handedly off-set by the more than 680,000 square feet of losses found in Irvine. “The transfer in absorption between these two submarkets was simply accredited to Broadcom’s move-out from their previous location at University Research Park in Irvine, to the company’s newly delivered build-to-suit campus in Irvine Spectrum.”

Meanwhile, the report indicates that all other submarkets appeared far more level, as the majority found themselves within 25,000 square feet of net zero occupancy change – only Buena Park/La Palma (59,000 square feet) and North/East Stadium (-47,500 square feet) appeared to stand out one way or the other.
According to Kenas, “New leasing activity (which excludes renewals) totaled 1.25 million square feet in the first quarter of 2018, similar to the prior quarter but well below the quarterly average of 1.8 million square feet observed over the past year. In terms of leasing, the majority of notable deals stemmed from renewals, which constituted five of the top eight lease transactions in the first quarter.”

According to the report, Five Point Gateway, a brand new 1 million square feet development in Irvine from FivePoint Holdings LLC which also now houses Broadcom as its largest tenant, marked the first completion of 2018. Two other major office developments remain under construction countywide, both scheduled to deliver this year. Once complete, the Quad at Discovery Business Center and Flight at Tustin Legacy will combine to bring 787,000 square feet online.

Kenas says, “New office construction in Orange County, especially over the past 15 months, has had a significant impact on the market, both in terms of new occupancies but also new vacancies for the time being. We appear to be on the downslope of the new office construction cycle, which will help in establishing equilibrium between demand and new construction while also keeping the region from being overbuilt.”

With several large assets trading, the first quarter reported 1.2 million square feet in total sales volume (user and investment), with nearly all stemming from investments. Overall sales volume was just shy of the 1.4 million square feet last quarter as well as its 1.5 million square feet average over the past five calendar years. Meanwhile, tallying 1.1 million square feet, investment volume also neared its prior quarter’s 1.3 million square feet level, as well as its equivalent five-year average of 1.3 million square feet.

“Following a robust 2017 catalyzed by Q2 and Q3’s more than 2 million square feet of volume each (sparked by pent-up supply/demand soon after investors, particularly institutional, regained confidence following the presidential inauguration), sales volume remains at solid levels in 2018 as investors continue to seek both well-performing or value-add real estate assets in our coastal markets,” says Ed Hernandez, managing director of Cushman & Wakefield Capital Markets in Orange County. “Orange County remains a desirable location given its ongoing stable market leasing fundamentals, high-quality labor force, and attractive live/work environment. As our report indicates, countywide investment activity remains close to our five-year average, but also of note is the level of historic high pricing being achieved for core assets. The most notable sale in the first quarter was Torchlight Investor’s selling the iconic City Tower, a 435,000-square-foot, class-A high-rise in Orange, for over $147 million or $339 per square foot to KBS. Four other large sales transacted with square footages between 139,800 square feet and 193,400 square feet that ranged in price from $32 to $42 million.”

Hernandez projects that, thus far, 2018 appears to be keeping on track with 2017 in terms of pricing, buyer demand, and volume. “Some assets that traded in the past two to three years are coming back around as pricing has increased. Blackstone may be the largest seller in Orange County over the next 12 to 24 months.”

Hernandez also comments on foreign capital, specific to China, adding, “While China-based investor activity has declined noticeably, established ‘on shore’ Chinese investors do continue to seek large high-profile properties in this region. We still expect Chinese inbound capital flow into the local market, just at a reduced and slower pace ahead in the short term.”