Jay Nugent

Office vacancy rates in Orange County increased again in the third quarter, making for seven consecutive quarters of increasing vacancy rates. As of the third quarter, vacancy rates is just above 12%, while absorption remained flat, according to research from Newmark Knight Frank. The increasing rate doesn't quite tell the whole story. In 2017 and 2018 combined, 2.3 million square feet of new speculative office space came to the market, which has contributed to the increasing rate.

“Orange County's vacancy rate has progressively increased as new speculative construction has come online and coincided with recent modest absorption activity,” Jay Nugent, senior managing director at Newmark Knight Frank, tells GlobeSt.com. “Historically, there is a notable time gap for leasing activity to catch up with new supply and tenants to subsequently absorb the speculative space. Over the past 12 months, 2.1 million square feet was delivered as new spec supply. To date, 67% of what has been delivered has been leased. In addition, one of the main factors could be that we are seeing historically low unemployment, which has caused white collar hiring to slow down.”

Nugent says that the vacancy rate will likely continue to increase as a result of the current construction pipeline and new deliveries. “While some tenants are expanding, others especially in the professional service industries are downsizing or consolidating their footprint which has a negative effect on vacancy,” he says. “For example in the first quarter of 2018, Broadcom took occupancy of 660,000 square feet of new space at Five Point Gateway, after downsizing from nearly a million square feet of space at UCI Research Park.”

Vacancy rates are increasing the most in submarkets where the construction pipeline is the largest. Specifically, that means the Airport Area and South Orange County—both of which have become the most popular submarkets. “An increase in vacancy rates is strongly correlated to an increase in newly delivered supply,” adds Nugent. “The Airport Area and South County submarkets have been the primary beneficiaries of the recent injection of new supply, resulting in slight upticks of their vacancy rates. The Irvine Spectrum micromarket specifically, has added 1.6 million square feet of speculative space over past 12 months, and its vacancy has shifted from 8.1% to 11.6% over the same period.”

While vacancy rates are rising, rental rates have only improved. Rates in the third quarter have reached near historical highs of $2.70 per square foot, a 1.8% increase. The new construction pipeline will only help to fuel more increases in rents. “New construction provides large efficient floorplates and unique features for tenants in search of modern space, it generally provides a product you cannot find anywhere else and therefore will command and get premium rent,” says Nugent. “This, in turn, should provide a “drafting” event of quality class-A and -B assets that are well amenitized to also push their rates. Where you will find rents being compressed is in product that has not been updated or amenitized and the rental rate will have to be the driver to capture the tenant. New product will achieve high water rental rates, however, once this current supply under construction is delivered, we will see rents start to stabilize.”