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ONTARIO, CA-The Inland Empire office market has been one of the top performers in the US for years, but it got off to a slow start this year, according to new reports on first-quarter trends. The financial markets take much of the blame.

Grubb & Ellis Co. headlines its report on the region: “Inland Empire Office Market Off to Slow Start,” pointing to increased vacancy, lower absorption and an increase in sublease space in the first quarter. The Inland Empire region, which includes all of Riverside and San Bernardino counties, totals about 24 million sf of office inventory. That makes it relatively small compared with major US markets, but the region has caught the eye of developers and investors nationally in recent years because it has performed so well statistically, posting low vacancy, significant rent growth and little sublease space.

In the first quarter, however, the vacancy rate for Inland Empire office climbed to 14.6%, up from 11.9% the previous quarter and 7.3% a year ago, according to the Grubb & Ellis report. The CB Richard Ellis figures are pretty close to those of Grubb & Ellis, citing an increase from 11.85% vacancy in fourth quarter 2007 to 13.78% in first quarter 2008.

Colliers International says that the changes make the Inland Empire “an attractive market for tenants,” pointing out that rising vacancy rates coupled with decreasing asking rates “are a natural consequence of the massive building boom that has finally reached its height.” The Colliers team further observes that “this slow and predictable increase in the office supply has been met with a rapid and drastic drop-off in demand as mortgage and real estate companies begin to come to terms with the bursting housing bubble.” Developers are responding to the changing market conditions by reducing the size of proposed projects, its team notes.

The CBRE report quotes John Oien, first vice president, who observes that, with respect to new development, “the Inland Empire is seeing a slowdown due to lender constraints, which is affecting the smaller players in particular. In addition, some new development projects are being put on hold, given other projects that are in further stages of development.”

John Daciolas, senior vice president in Grubb & Ellis’ Ontario office, says “we’ve really seen the impact of the economic slowdown in the office market. Tenants in today’s market will find they have a lot more options with the shift in market conditions, especially for class A space.”

Grubb & Ellis’ quarterly survey cites negative net absorption of 127,201 sf in the first quarter, with the inventory of available sublease space growing to 410,542 sf from 320,458 sf at the end of last year and 95,565 sf since Q1 2007.

Most office development in the Inland Empire in recent years resulted from the region’s expanding population, which in turn attracted new residents and the economic base of the region began to diversify, Colliers points out. Most office tenants in the Inland Empire are firms predominantly in finance, insurance, real estate and professional services sectors. And, most of the space is relatively new, with 83% built in 1980 or later, according to the report.

Despite changing market conditions, CBRE’s team found the region’s average asking lease rate increased from $1.98 per sf per month in Q4 2007 to $2.01 per sf per month in Q1 2008. Grubb & Ellis researchers peg the average asking rate for class A space was $2.19 per sf in the first quarter, equal to the previous quarter, and up seven cents from a year ago. Class B space was going for $1.80 per sf, down from $1.86 the previous quarter and $1.84 a year ago.

One of this year’s questions will be whether the Inland Empire can manage positive absorption for the year. Last year, even with the weakening economic conditions, the Inland Empire posted 1.1 million sf of positive absorption. The region also scored one of its biggest deals in years, the Wells Fargo Home Mortgage leasing of 230,728 sf at Opus West’s 283,000-sf Northpointe office development in San Bernardino.

“The market will likely be challenged well into 2008 thanks to continued downsizing in the financial services/real estate sectors,” Daciolas says. “The Downtown business districts of Ontario and Riverside will see the quickest turnaround based on the amenities they offer and the strength of the surrounding demographics.”

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