Western Real Estate Business

JUL 2018

Western Real Estate Business magazine covers the multifamily, retail, office, healthcare, industrial and hospitality sectors in the Western United States.

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M A R K E T H I G H L I G H T: O R A N G E C O U N T Y 16 • July 2018 • Western Real Estate Business www.REBusinessOnline.com CREATIVE OFFICE CONSUMES ORANGE COUNTY Orange County gained 2.2 million square feet of new product in 2017. There's 800,000 square feet coming to market this year. That's about 3 million square feet of new space in just two years. Last year maintained its seventh consecutive year of positive absorp- tion, although it was down due to new development and corporate consolida- tions. The county posted 1.6 million square feet of annual absorption, down 24 percent from the year prior. Corporate consolidations included semiconductor leader Broadcom, which went from 900,000 square feet to 660,000 square feet, as well as serv- er and storage products manufacturer QLogic that went from 165,000 square feet in Aliso Viejo to 106,000 square feet in Irvine. We expect more consoli- dations to follow as companies seek out efficiencies and open, creative workspaces. New product is also causing up- ward rent pressure. Asking lease rates for most new product is about $4 to $4.35 per square foot. Existing Class A buildings in and around the Airport submarket remain around $3.25 to $3.35 per square foot. All the new development reflects demand for creative office — a trend that's been picking up speed over the past two to three years. These spaces are not only efficient for companies, but they typically come with more amenities. Orange County's unem- ployment is also at 3.3 percent, which means there are more jobs than peo- ple. Companies are using their work- spaces as recruitment tools, adding food services, bar areas, relaxation rooms and more. New office product is also support- ed by the fact that much of Orange County's land or older office prod- uct is being repurposed for multi- family or industrial uses, which are also at a premium. The reality is the market would not have been able to finance and build 3 million square feet of new product without confi- dence in continued job growth from expanding and start-up tech compa- nies, service industries, real estate- related companies, legal and medi- cal services, which all remain active in the market. The Irvine Spectrum submarket is staying strong. Irvine Company built two new 400,000-square-foot office towers in 2017. The company also has the Quad at Discovery Busi- ness Center, a 370,000-square-foot, four-building low-rise campus with outdoor work spaces under develop- ment, which is 65 percent pre-leased. LBA Realty is further redeveloping the former Toshiba campus into a 448,000-square-foot creative campus in Irvine. With all this activity, there is almost 2 million square feet of new construction and re-development projects in that submarket alone. The Airport submarket has a num- ber of redeveloped office campuses as well. LBA Realty is repurposing a St. John Knits plant into creative of- fice. Hines is repurposing an older four-building campus into new cre- ative space. Trammel Crow completed Boardwalk, a new two-building, nine- story office midrise. Not far from that activity is the former Tustin Marine base, which is being master-planned into a 1,600-acre community that will include Lincoln Property Company's FLIGHT, which accounts for almost 500,000 square feet of new creative space. Looking ahead, there are few value- add investment opportunities to be found in this market. Capital is buy- ing core or core-plus assets at higher prices for long-term holds. Owners are gutting spaces, opening them up and making them more efficient as tenants turn over. Chances are high this will be an ongoing business plan in this market for a while to come. Robert E. Griffith Executive Managing Director of Investment Services, Newmark Knight Frank NEW INDUSTRIAL PRODUCT EASES DEMAND IN OC Orange County continues to re- main one of the most constricted markets for industrial property, with a vacancy rate of 2 percent, representing a 50 basis point drop since this time last year. Demand in the Orange County market continues to remain strong. This historically low vacancy rate has also brought about an 8.7 per- cent increase in lease rates. The steady rise in lease rates, as you can imagine, has contributed to a significant increase in industrial property values. A direct reflection of this is the 14.5-acre Ricoh Tustin property that is cur- rently for sale. The project will soon be redeveloped with newer industrial buildings. Land pricing is suspected to top $65 per square foot (land) as a watermark. Along with the Ricoh Tustin property, Boeing is in the process of selling a 30-acre portion of its Huntington Beach campus. The property has two office buildings that will most likely be razed to develop a roughly six-building industrial campus ranging from 60,000 square feet to 150,000 square feet. Pricing is projected to be in the $55 per square foot (land) range with the buyer needing to take on environmental remediation. In a market where tenants are struggling to find future space options to meet their needs, the influx in future Class A product could not come at more ideal time. Jace Gan Associate, Colliers International The private capital segment of the Orange County multifamily market has matured to a low cap, higher price per unit, and loftier price per square foot marketplace. While this has been compounded by the steady rise in rental rates, it has also been buoyed by the stronger and more di- verse Orange County economy. We are continuing to see record sales at radically compressed cap rates. This activity has continued despite the fairly dramatic increase in apartment financing rates, which are about 150 basis points above rates from February 2017. As an example, a recent 28-unit sale in a desirable submarket of Costa Mesa traded at a 2.8 percent cap rate. The property's current rents were 28 percent under market and the as- sumable financing was at a higher loan-to-value and a lower interest rate than the asset supported on a purchase money basis. We are experiencing very low loan-to-value ratios on sales because most private capital owners usu- ally manage for occupancy versus market rental rates, especially in the coastal submarkets. The low cap rate environment is not only a result of the steady appreciation in this cycle, which we believe is very much at its peak, but the unwillingness of many private capital owners to increase rents to market levels. Rental rates in Orange County have increased close to 50 percent over the past eight years. While we believe this will continue, we are seeing lower year-over-year rent growth. We are continuing to underwrite assets with rents anywhere from 10 per- cent to 30 percent under attainable market rents. This has driven the in- place cap rates to historic lows. Current rents on our most recent offering of a prized 66-unit port- folio in Newport Beach are 19 per- cent under market. Despite a sub-3 percent in-place cap rate, we have conducted numerous tours and generated multiple competing of- fers prior to full market exposure. There is certainly a crowd of inves- tors reluctant and averse to acquir- ing on these fundamentals. Many believe the "cap on cost" drives the market cap rate down by as much as 20 basis points when renovations costs $15,000 to $50,000 per unit. That budget often does not include the exterior improvements, such as drought-tolerant landscaping and repurposing the exterior common area into resident communal set- tings that are modeled after Class A assets. Much of the multifamily develop- ment in Orange County is concen- trated around the Irvine Business Complex, which is all Class A prod- uct with asking rents exceeding $3 per square foot. Developers have no other options than to construct high- ly amenitized, Class A communities due to the lack of infill developable sites, high cost of construction, and the drawn-out and expensive en- titlement process. As a result, we are already seeing rental concessions that include up to two months of free rent with this stock of inven- tory coming online across Orange County. With this in mind, the majority of Orange County's housing stock that was built between 1960 and 1980 is now providing "affordable hous- ing" alternatives to this wave of new construction. OLD MEETS NEW IN OC'S MULTIFAMILY MARKET Steven C. Brombal Senior Vice President, Kidder Mathews

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