Subprime Slump Batters OC Office Market

The year-end tally shows that negative absorption totaled 947,370 sf for 2007, a result primarily of a fourth quarter in which negative absorption totaled more than 1.2 million sf. That fourth-quarter number reflected the huge volume of space dumped onto the market by mortgage-related companies either downsizing our going out of business.

Despite the negative numbers, the county's 103-million-sf office market is doing better than might be expected and is faring better than it has in previous slumps, according to Jerry Holdner, a vice president and chief of research at Voit Commercial. Holdner points out that the year-end vacancy rate of 12.4% in Orange County, although up from 7.91% at the end of 2006, is lower than the 17.2% vacancy rate in the first quarter of 2002 and far lower than the 24% vacancy rate in 1988, a year in which 5.7 million sf of new space hit the market.

In addition, Holdner tells GlobeSt.com, it appears that much if not most of the damage from the subprime fallout has been done, while other factors in play right now could drive recovery in the office market later this year. He explains that one factor slowing the market in recent months has been the credit crunch, which has caused many tenants to delay leasing decisions. As the year goes on and the credit situation gets ironed out, he expects leasing activity to grow.

The county's office market is also holding its own in light of the huge amount of new space that has been delivered in recent years. Developers have delivered some six million sf of new office space in the past three years, and 2006 was the third-highest year ever for new construction in the county, with 4.4 million sf. The pace of new construction is slowing, however, with only about 1.5 million sf of new buildings expected for the rest of this year.

The mortgage industry occupied about eight million sf of office space in Orange County at its peak and now occupies about 5.5 million sf, according to Voit estimates, although the exact amount of space occupied by mortgage-related firms is difficult to determine. The emptying-out of the mortgage firms' space and the related economic slowdown are having less of an impact on the sublease market, however, than has been the case in previous cycles when tenants vacated large amounts of space.

Most of the mortgage companies' space is only staying on the sublease market for a relatively short time because most of the firms had relatively short-term leases. Voit's figures show that the combination of direct and sublease office space available in the county totaled 17.07%, meaning that sublease space represented about 4.6% of the vacancy. That's up 1% from the end of 2006, when sublease space totaled about 3.6% of the available office space and the total of direct and sublease space was 11.5%.

Despite the slowdown after years of robust growth in the county's office market, Holdner cites a series of factors that promise to get the market back on the growth track, including the region's strong local economy, high quality of life and growing industries such as high technology, biotechnology and healthcare. In addition, average asking rates have managed to remain firm, rising to $2.77 at the end of 2007, an increase of more than 9% from the end of 2006. Average asking rates for class A space are averaging $3.02 full service gross countywide and $3.21 in the airport submarket.

Holdner expects lease rates to remain at current levels for the short run. Concessions should begin to increase in the forms of free rent, reduced parking fees, relocation funds and tenant improvement allowances as new inventory becomes available from construction deliveries.