Positive Signs Emerge in County Office Market

ORANGE COUNTY, CA-The Orange County office market posted positive absorption for the first time in 11 quarters and showed other signs of what might be the beginning of a recovery, according to two newly released second-quarter market reports by CB Richard Ellis and Voit Real Estate Services. Voit's report still showed negative absorption during the second quarter, but both CBRE and Voit tell GlobeSt.com that the second-quarter results have them hopeful that the market may have reached bottom and started slowly turning for the better.

"It's only one quarter, so we can't say for sure that it's the beginning of a trend, but it's encouraging," CBRE managing director Jeff Osborn said of the company's second-quarter OC office report, which showed positive absorption of 198,697 square feet. That compared with negative net absorption of 597,440 square feet in the second quarter of last year, according to CBRE.

Voit's second-quarter report showed 143,257 of negative net absorption in the quarter, but Voit VP of market research Jerry Holdner pointed out that the figure was down substantially from the negative 608,703 square feet in the second quarter of last year. Both Holdner and Osborn said that despite the differences in their absorption figures for the second quarter, both companies' market surveys are showing the same general trends, and differences in specific statistics are easily explained by differences in the size of inventory the different firms track and other aspects of how various real estate firms assemble their reports, such as when the cutoff dates are for data that goes into the reports. Voit, for example, tracks approximately 110 million square feet in the county, compared with CBRE's approximately 100 million square feet.

Holdner said that although Voit's figures still showed negative net in the second quarter, the smaller negative net is one of a number of signs that the Orange County office market may be stabilizing and starting to head in a positive direction. For example, availability is stabilizing, down almost a full percentage point from last quarter and up only .66 of a percent from last year. In addition, "We are seeing more three- and five-year leases, where a year ago it was all one- and three-year deals," Holdner said. He is also hopeful that improvement in the county's industrial market, which showed positive absorption for the first time in seven quarters in Q2, may be a harbinger of things to come in the office sector.

Both Holdner and Osborn are cautious about reading too much into the second-quarter figures, however, pointing out that it's too early to declare a turnaround. This is especially true with lease rates continuing to decline, general weakness remaining in the market and job growth―essential for an office market recovery―remaining a question mark.

"We're happy with the growth in the activity that we are seeing, but the critical issue to us right now is job growth, and whether it will be sustainable," Osborn said. "We've all heard that from the national and state level, but it applies here on a local basis as well."

To some extent, the hints of improvement in the Orange County market mirror those that have been reported recently in other parts of the country. Both CBRE and Cushman &Wakefield, for example, said in media briefings last week that Manhattan’s office leasing market for 2010 is on pace to look more like 2007 or even 2005, and C&W reported that the average vacancy rate in 31 CBDs across the US has declined for the first time since ’07. Jones Lang LaSalle also reported a vacancy decline across the major US markets for the first time since 2007.

Osborn observes that, "Whether you go macro to a global level or locally, there are signs that a recovery is on its way, but I would say that we are in the early stages, and it remains fragile."

That fragility is reflected in the market reports from CBRE and Voit, which both still show widespread weakness in the Orange County market, which has been one of the most battered by the recession, in part because of the concentration of failed subprime mortgage firms in the county that vacated huge blocks of space at the outset of the downturn. Voit and CBRE both quote the same average asking rate in the second quarter, $2.06 per square foot per month, and both say that the rate continued to decline in the quarter, as it has ever since the market turned south. Availability remained high as well, with CBRE showing it at 4.7% and vacancy at 18.2%; Voit has availability at 2.96% and vacancy at 18.3%.

Anecdotal evidence also points to continued weakness in the office market, with landlords reducing rent and offering generous concessions to keep and woo tenants. Some landlords have only recently and reluctantly started to lower rates, according to Holdner, who says that the holdouts have realized that it's the only way to remain competitive. Office sales have been sluggish too, although a few large transactions have closed, including Kilroy Realty's $103 million acquisition of 2211 Michelson Dr.

Voit's figures show 2.8 million square feet of sales and leasing in the second quarter, compared with an average of 3.2 million square feet over the past nine quarters, and Holdner describes the 2.8 million as "fairly close" to historical levels of activity. The numbers show that the market, while still weak compared to pre-downturn days, is surely not at a standstill.

According to Osborn, the industry sectors that are sustaining the activity are technology, healthcare and education, which he describes as "the mainstays of the Orange County economy have always been here," as well as growth in the federal and state governments. He points out that most of the activity in leasing today continues to be renewals, including the blend-and-extend deals that have been popular with landlords and tenants alike. "Landlords understand that it's beneficial for them to keep a tenant, albeit maybe at a lower rate, because cash flow is king today, and keeping existing tenants is just as important as getting new ones."

How the county's office market will fare for the rest of this year is tough to fathom, according to both Osborn and Holdner, because it depends on factors like the overall economy and job growth. Osborn says that the signs of improvement in the second quarter "may reflect the overall economy," but "jobs are critical" to an office market comeback. Holdner echoes the sentiment, noting that Chapman University in Orange County forecasts job growth beginning in September in the county, but that growth "is not going to be gangbusters" and will likely only replace the jobs that were lost in the first part of the year, so it remains to be seen when the county will gain enough jobs to turn the office market around.