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INLAND EMPIRE-The Inland Empire office market has led a charmed life in recent years, growing in size along with the economy and building much more class A space as white-collar jobs moved into the region from elsewhere in Southern California. Even during the last economic downturn, the region’s office market has fared better than most because it posted job growth, helping to keep the office market healthy while many parts of the nation lost jobs.

The latest downturn is a different story, however. Grubb & Ellis Co. points out in its latest report on the region that “an attempt to assess the market’s true vitality is tricky” in light of the impact of job losses in housing-related businesses, which are big users of office space. In addition, the Inland Empire has been one of the hardest-hit regions in California in terms of foreclosures.

On the positive side, Grubb & Ellis researchers report the Inland Empire [Riverside and San Bernardino counties] performed well in 2007, with absorption and construction levels that nearly matched those of 2006. But the amount of sublease space on the market doubled on a quarter-to-quarter basis in the last two quarters as housing-related firms either pulled out of their spaces or downsized and placed some of the excess on the market.

In a CB Richard Ellis report, overall absorption clocked as being down in the fourth quarter from the previous quarter, but absorption nonetheless remained positive. And despite rising defaults in the subprime mortgage sector, the team concludes “the IE office market remains diverse in its tenant base and has shown incredible resilience to the weakening subprime mortgage market.”

Even with the weakening economic conditions, the Inland Empire posted 1.1 million sf of positive absorption in 2007, with 98% coming from new buildings completed during the year. One of the biggest deals driving the absorption was Wells Fargo Home Mortgage’s leasing of 230,728 sf at Opus West’s 283,000-sf Northpointe office development in San Bernardino.

One response to changing market conditions by developers has been to build their office projects in phases, thereby “delaying a given project’s subsequent groundbreaking until initial phases have logged significant preleasing activity,” Grubb & Ellis’ team points out. Additionally, many developers may reconsider certain projects: “scrapping plans for a behemoth mid-rise in favor of two smaller buildings.” Nonetheless, Grubb & Ellis’ researchers say “the addition of new sublease space will pose a headache in the months to come, especially when noting that much of fourth quarter’s 320,458 sf of available sublease space came from newer class A inventory.”

CBRE’s researchers conclude the upshot of all of the market changes and the economy is that overall net absorption has slowed in the Inland Empire office sector, sliding to 61,936 sf in the fourth quarter, compared to 213,409 sf in the third quarter. At the same time, the overall vacancy rate increased from 11.22% 11.85% in the 23.5-million-sf inventory, according to CBRE. Grubb & Ellis pegs the vacancy at right about the same number as CBRE, but it points out that the figure is up from 7.6% on a year-to-year basis.

The slowing momentum of the economy has finally pushed average asking rates down, according CBRE. It says that the average ask across the entire IE office market was $1.98 per sf, down from $2.01 per sf in the previous quarter.

Despite any temporary setbacks, both CBRE and Grubb & Ellis see a bright future for the Inland Empire office market. Notes Grubb & Ellis: “Aging Baby Boomers eyeing retirement, many of whom will move to the Inland Empire, will strengthen the region’s demand for medical office space.” Kaiser Health Foundation Plan already has acquired a new 23,709-sf building in Temecula and a proposed Murrieta hospital campus with supporting office space recently was announced.

Santa Ana-based Grubb & Ellis cites other factors working in favor of the Inland Empire market, including the region’s population of more than 4.4 million that remains underserved by professional companies, a diversified tenant mix that is not linked solely to the residential sector, rental rates that are very competitive compared with surrounding counties and a growing college-educated population that is willing to work for lower wages and salaries in order to avoid time-consuming commutes to other counties. “Such advantages will ultimately work in the region’s long-term favor,” Grubb & Ellis says.

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