Why Class-B Office is Hot in OC

ORANGE COUNTY, CA—The brightening office market is spilling over into class-B properties, which are gaining investor attention because of their low vacancies and improving rents, Cushman & Wakefield's senior analyst—research Jared Dienstag tells GlobeSt.com exclusively. The firm recently released a first-quarter office report that showed most of the office trades in the county involved class-B properties. We spoke with Dienstag about why he believes this is happening, how class-A office properties are faring and the types of office properties investors are eyeing in this market.

GlobeSt.com: What is happening with class-B office investment in Orange County?

Dienstag: The market has turned in a positive growth direction. Whereas the class-A buildings tend to attract institutional investors, other types of investors are attracted to class-B buildings. Class-A is always going to have higher price points and be concentrated in the greater Airport area submarket, but class-B doesn't get as much attention. Class-A is also always occupied by investment-grade tenants. But the situation has improved significantly for class-B because there are only so many opportunities available in class-A, and only institutional investors are in a position to acquire them. So, a lot of investors are turning toward class-B buildings because their vacancy is very low, rents are starting to perk up and some investors are becoming bullish on them as solid investments—both well-leased and value-add buildings. Also, with rents rising, some class-A tenants could get squeezed out of that class and begin to turn toward class-B, which may increase occupancy in class-B relatively quickly.

GlobeSt.com: Where is the majority of class-B space located?

Dienstag: It's really located throughout the county, although the greater Airport area and South County get the lion's share of it. It's similar to class-A in this way because the two submarkets are the most attractive. Sales of class-B buildings in the quarter were spread throughout the county, and it's great that it's not 100% concentrated in one area. There was some sales activity in North County—no so much this quarter, but in fourth-quarter 2014 North County saw quite a bit of investment activity. The largest sale last year was a class-B building in North County that was more than 600,000 square feet—the Bank of America building. There were others in North County last year also.

GlobeSt.com: As the economy continues to recover, what types of office properties will investors seek in this market?

Dienstag: The class-B activity will definitely stick around for the time being. It really depends on the investor's risk tolerance. The one class-A building that sold during this quarter was almost 100% leased to Hyundai Capital, so institutional investors will almost always be attracted to those types of opportunities, especially in Orange County, which doesn't have as many global companies as what you would find in New York, Boston, L.A. or San Francisco. Opportunities to acquire those buildings are really few and far between in this market. A lot of institutional investors outside of Orange County aren't familiar with other areas of the county for office because they rely on boots-on-the-ground to get their information, and those people say the Airport area is the place to be. But they are starting to look where there's more opportunity in some of these other submarkets.

GlobeSt.com: What else should readers take away from your Q1 report?

Dienstag: Central County, which has been the slowest to recover from the downturn, had a solid quarter in net absorption, which is a good sign for the area. It's great to see the market turn the corner for Central County. A lot of sub-prime mortgage companies took up large blocks of space before the recession, and it was a slow submarket to recover. Market watchers don't always tend to look at submarkets like those, but the fact that class-B is performing well there is a sign that regional and smaller companies are starting to lease space.