Office Market in 2010 Faces Repeat of '09

ORANGE COUNTY-The county’s office market will continue to struggle this year, with rents continuing to fall and most of the leasing action in short-term renewals. That’s one of the conclusions of new reports and forecasts suggesting that the county’s office market, once one of the strongest in the country, will take years to recover.

Recently issued reports from Voit Commercial Real Estate Services, CB Richard Ellis and Delta Associates indicate that 2010 will resemble 2009 in the Orange County office market, although with some changes. “Lease rates will continue to fall, but not nearly at the velocity of the past 18 months,” says Kurt Strasmann, a managing director at Voit, who says the market appears to be at or near bottom, but adds that years will pass before it goes the other way and rents start to climb. Delta’s report, which it produces in in conjunction with Transwestern, echoes that sentiment, saying that the office market “continues to retrench, but the rate of contraction has slowed.”

The county ended the year with average asking lease rates ofof $2.17 per square foot per month, compared with the record high rate of $2.77 that was established in the fourth quarter of 2008, according to Jerry Holdner, a Voit VP and chief of research for the Orange County-based company. CBRE pegs the rate at $2.19 and Delta has the rate at $2.16. Voit tracks about 108 million square feet of office space in the county, while CBRE tracks approximately 100 million square feet and Delta lists more than 119 million square feet.

Despite a 2009 in which rents fell, direct vacancy climbed to 17.48%, availability climbed to 23.42% and negative net absorption totaled 2.9 million square feet, the leasing market remained active and is likely to continue so, according to Strasmann. Leasing totaled 8.8 million square feet for the year, an increase over 2007 and 2008, according to Holdner.

Strasmann explains that the increased leasing activity reflects the reluctance of tenants to sign long-term deals in a time of uncertainty and the willingness of landlords to agree to the shorter terms. “One strategy for tenants is to renew for a year or two because they don’t know what is going to be happening with their businesses,” he says. The renewal activity will remain fairly constant this year and in coming years because, “Those short-term deals will turn over again over the next couple of years,” Strasmann says.

According to Jeff Osborn, a CBRE managing director in the company’s Anaheim office, the actions of tenants in this market reflect that, although office markets throughout the country face the same tough times, Orange County “faces unique challenges many markets do not.” Because of “the abundance of office product located within the county and its corresponding high asking prices,” he says, businesses “are forced to make difficult decisions” in terms of their office space. Many companies have elected to consolidate, accounting for more than 3.6 million square feet of sublease space currently on the market, Osborn says.

Nonetheless, some tenants and landlords are willing to sign longer deals, according to Voit’s Strasmann. “Most of the owners now feel that with rents continuing to decrease, and with so much availability in the market, there won’t be any rent appreciation for at least a couple of years, so they will do five-year deals now,” the Voit managing director says. However, he adds, “Landlords are looking very carefully at the financial stability of each tenant,” meaning that before they sign a long-term deal or grant generous concessions, they want assurances that the tenant is a solid credit risk.

Despite the weak market and the expectations that it will continue that way, some of what is happening in the county does help to set the stage for recovery when the economy turns and demand for space increases. The reports from Voit, CBRE and Delta all point out that construction of new space has slowed to a near halt, the rate at which empty space is being added to the market has slowed, and there are signs of increased sales activity, some of it in distressed assets like the $53 million FDIC sale of the former Downey Savings & Loan headquarters and Los Angeles-based Highridge Partners’ $31 million acquisition of a building at 3 MacArthur Place that sold for $83 million in 2007.

CBRE’s forecast predicts that average asking rents in Orange County will continue to decline into 2011. The company’s overall outlook is that, “With the increases in unemployment, state and nation-wide, Orange County will continue to muddle through these times with high office vacancy for the foreseeable future.”

Voit’s Holdner says that, as negative absorption starts to slow and with no new deliveries in the pipeline, the market should begin to stabilize later this year. Holdner points out that, in Orange County as elsewhere, jobs will be the key to any recovery in the office market. He cites economic forecasts predicting that the county will continue to lose jobs for the first half of this year, then start producing new jobs in the second half. “Once job creation turns positive and consumer confidence stabilizes, then the office market will turn positive,” Holdner says.

For that to happen, according to Strasmann, the county will need either a general increase in demand among all types of office users or a growth industry to drive demand. “Until there is a driver in the market, it will be tough for us to come out of this,” he says.