New Leases Despite OC's Biggest Weakness

NEWPORT BEACH, CA—Lack of a strong public-transportation system as compared to New York or San Francisco doesn't seem to be stopping new office tenants in Orange County, Newmark Grubb Knight Frank's senior managing director Tim Marchal tells GlobeSt.com. After the firm's Q2 office report showed that asking rents for office properties took quite a jump in the second quarter, we sat down with Marchal to chat about office dynamics in the county and what to expect as we enter the second half of the year.

GlobeSt.com: What has influenced the recent rise in asking rents for office properties in Orange County?

Marchal: It's a combination of multiple items, one of the biggest being decreased vacancy. Depending on which numbers you look at, we're right around the 10% or 12% vacancy range, and some submarkets are in the single digits. Different companies use different metrics to determine vacancy, and our numbers may be a little higher because we wait until tenants occupy to figure it into the vacancy rate, but getting down to single digits is huge. Also, our rates were so depressed during the Great Recession that we're still well below peaks. Asking rents were in the $2.79 to $2.80-per-square-foot range, and now they're 20% to 30% below peak. That doesn't mean we can't succeed—we've been very disciplined in development, which is another reason why asking rates are going up and vacancy is going down. We haven't built anything in a while. Irvine Co. will deliver space in Irvine Spectrum in April, but for the most part we haven't built any new office product. Those factors have combined to push rates up.

Also, there's been a lot of investment activity in Orange County. A lot more product is changing hands, and much is for sale or coming for sale after Labor Day weekend. With that, investors are underwriting higher rents. That's helping to push rates up as well—new, well-heeled owners coming into the market figuring that they paid “X” for a building, so they're going to ask “X” for rent.

Another factor influencing rental rates is unemployment. We're at 4.2% unemployment in Orange County, which is the lowest it's been since October 2007. I'm not economist, but if you look at some of these things, it's pretty incredible—the organic growth from companies in the market and new tenants coming in.

GlobeSt.com: What's behind all of the new leases being seen in the market?

Marchal: It goes to Orange County being a great place to live, work and play. Public transportation that other cities like New York, Boston and San Francisco enjoy is really our biggest weakness. But beyond that, you can't take away the location and all the other factors, and it's a fantastic place to do all those things. Plus, it's still relatively cheap compared to New York and San Francisco—Orange County is well below some of those markets. Fashion Island and Newport have the highest rents of $6 to $8 per square foot, but overall Orange County is relatively less expensive. Why wouldn't you expand here?

GlobeSt.com: What is the most interesting fact about investment sales for office in this market?

Marchal: At the end of 2015, Orange County came in number-11^th for investment activity, behind New York, San Francisco, L.A. and right behind Denver. And a lot of major companies nationwide are coming into the market: Invesco, Clarion, Hines with Pimco. They are all names everyone's heard of, and certainly there's some foreign investment in Orange County, but on the face of it these are household names for the most part.

GlobeSt.com: What else should our readers know about the Orange County office market?

Marchal: We're in some of the earlier stages of creative or progressive office product. Certain investors like Bixby Land, which is working on its fifth project in Orange County after doing a lot of work in Northern California, are doing that here. It's not like Silicon Beach or Silicon Valley, but we certainly have projects spread throughout the county like that, including Lincoln Property Co. and the City of Tustin kicking off in Q1 2016 with construction on Cornerstone I at Tustin Legacy, which will be the first full-blown ground-up creative project in the county. Others are repositioning.