OC Office-Condo Market Soars Despite Tight Supply

Hartel: “There’s has been nothing but good news for developers of office condos in the last few years as sale prices have hit new historic highs in Orange County since the end of the recession.”

IRVINE, CA—The office-condominium sector is an often-overlooked segment of the Orange County office market, but, as GlobeSt.com has previously reported, this segment has become quite popular, and demand for these properties has skyrocketed. Office condos come with a deed of trust and all of the benefits of residential condos—including interest-rate write-offs and increases in property value. But there also are significant differences: the owner has the luxury of knowing there are no landlord, no lease expiration dates with built-in rental bumps, no negotiations over extensions and, again, tax advantages and equity growth.

We recently sat down with two of the recognized experts in the field, Colliers International’s EVP Michael Hartel and SVP Joe Winkelmann who, as a team, have sold more than 600 office condos over the course of their careers. We spoke with them exclusively about why interest has spiked so dramatically in the office-condo market in Orange County and why inventory remains in such short supply.

GlobeSt.com: Why is the office-condo market taking off now, especially in Orange County?

Hartel: Simply put, lack of existing inventory versus high demand. Since the end of the Great Recession, demand has consistently risen for office condos, but cautious developers and their lenders took a while to get on board after being hit so hard during the downturn. The result has been a lag in new or renovated space. But, while nearly 3.5 million rentable square feet of new Class A office space has been added to Orange County’s inventory since the recession, there has been no new construction of office condominiums. Additionally, Interest rates on an office condo are at all-time lows, and office lease rates are at an all-time high. If a tenant does the math, it comes out in his or her favor.

GlobeSt.com: What types of tenants and in which fields do best in office condos?

Winkelmann: Most office condo buyers are professional-service firms such as attorneys, accountants, architects, financial advisors, insurance and advertising agencies and other smaller service firms. They typically employ from four to 40 workers and are sole proprietorships, S Corps and LLCs.

Winkelmann: “Primarily, smaller users are entrepreneurs who prefer the culture of a small firm and are content staying small. With less-ambitious growth plans, ownership works for the long term.”

GlobeSt.com: Tells us about your new project in Newport Beach that recently came on the market.

Hartel: We’re representing the Jetty, a contemporary, 87,340-square-foot creative-office condominium campus near John Wayne Airport in Orange County, which recently underwent a thorough renovation and repositioning. Overlooking Newport Beach Golf Course, suites at the Jetty range from 1,000 square feet to 10,000 square feet. The ability to own office space in Newport Beach is a unique opportunity.

Winkelmann: The Jetty has attracted a variety of tenants mainly in service industries who are attracted to this particular project because opportunities to acquire small creative-office space, especially in Newport Beach specifically and Orange in general, are extremely rare. The Jetty is also unique because of the smaller-sized condos in the 1,000-square-foot to 6,000-square-foot range.

Hartel: I’d also add that in the past, “small” has been 8,000 square feet to 10,000 square feet. Having smaller condos caters to the widest buyer audience today. The average tenant requirement at this particular project is in the area of 2,500 square feet (10 people), although, again, sizes range from 1,000 square feet to 10,000 square feet (firms with four to 40 people). I guess you could say the average office-condo tenant profile has changed.

GlobeSt.com: What types of requirements are you seeing in today’s market?

Winkelmann: To give you an idea, if the tenant’s acquisition requirement is for a smaller building, we have premium buildings of 8,000 square feet and 12,000 square feet listed in the Newport Corporate Plaza on Campus Dr. at Von Karman Ave., half a mile from the airport.

Hartel: Yet, at the same time, we are seeing requirements from 1,000 square feet for attorney groups all the way up to those 8,000 square feet to 10,000 square feet for tech and marketing companies, which is becoming a bigger segment of the market. Primarily, smaller users are entrepreneurs who prefer the culture of a small firm and are content staying small. With less-ambitious growth plans, ownership works for the long term.

GlobeSt.com: What are developers saying and thinking these days?

Hartel: There’s has been nothing but good news for developers of office condos in the last few years as sale prices have hit new historic highs in Orange County since the end of the recession.

Winkelmann: I would add that lease rates for office space is are now at pre-recession highs. In the last three years, average asking rents have jumped 24%. That’s huge. For creative space, almost all the recent demand has been for spaces of 12,000 square feet and less, and that’s where the opportunity lies for office condos. There’s never been this much supply-demand imbalance for office condominiums, so developers of them are thinking positive.

GlobeSt.com: What are the advantages to owning an office condo versus renting?

Hartel: Advantages of owning versus leasing office space are personal and corporate tax benefits and fixing your office expenses; typically, mortgage payment are flat and lease rates increase annually. Monthly market lease rates are very close to the amount of the monthly mortgage payment, so if you have the 10% down payment (SBA loan) you can own for about the same cost as leasing. We find that many of the buyers are looking for alternative ways to diversify their investments; they may feel they have enough invested in the stock market, retirement accounts and so forth that this gives them another avenue for building equity.

Winkelmann: Also, when you own your office space, forget about the pain that comes at lease renewal time. Instead, add up your savings from tax deductions and other benefits that come with ownership. Plus, with your costs are fixed, and that equity Mike just mentioned is something you certainly do not do as a tenant who leases space.

GlobeSt.com: What’s the biggest worry among those buying office space instead of leasing?

Winkelmann: There are just as many office-condominium buyers who have anxieties about buying too much space as there are who regret not buying enough space. This is especially true for companies in that 5,000-square-foot to 10,000-square-foot size category, and even smaller firms—this is their biggest worry.

Hartel: And don’t forget that as an owner, you can choose to rent out any excess space, or even the entire space, if you don’t need it or want to vacate it. There’s also the possibility of selling and then buying additional space. It’s a very flexible product for the typical tenant we see. Either way, an owner still comes out ahead.

GlobeSt.com: Where do you go for a loan when you want to buy an office condo?

Winkelmann: Great question and one we get all the time. If you ask your banker, you likely will be advised to apply for an SBA loan. With 10% down, the Small Business Administration guarantees up to 90% of the purchase price in either the SBA 504 or SBA 7(a) programs.

Hartel: But there are many lenders out there who finance office condos and carry the paper on a mortgage, just like on your home. At the end of the day, if you need office space for your business to occupy, then you will either pay rent to the landlord or you can pay rent to yourself—in any event, you will have occupancy costs. We see a preference of most office users to pay themselves when given the opportunity.

GlobeSt.com: What else should our readers know about office condos?

Winkelmann: Convenience and access are usually very important to office-condo buyers. That’s why both of the office condo campuses we’ve listed in Newport Beach consist of single-story and two-story buildings with free surface parking, which is so popular with employees and clients. Both projects have superb access to the Corona del Mar (SR-73), the Costa Mesa (SR-55) and San Diego (I-405) freeways.

Hartel: As Joe just said, location, location, location. It is a unique opportunity to be able to purchase office space with a Newport Beach address. Most of the office buildings in Newport Beach are owned by the Irvine Co., and they are not sellers. The supply of new space coming on the market is constrained by the lack of land available for development. As the population continues to grow, demand will continue to grow—if you have constrained supply and have increased demand, you have appreciation.