By Tucker Hughes

Orange County’s commercial real estate market fundamentals continued to improve through the end of 2015. We saw the total absorption of office space countywide for the year reach 1.4 million square feet, vacancy rates drop to 11%, and average time for an available space to lease drop by nearly 10%. This positive momentum has already manifested itself in higher rental rates, with landlords increasing rents from an average of $2.07 per square foot to $2.23 on an “all-in” basis.

We also saw strong absorption numbers on the industrial side of the county with net absorption for the year reaching 2.5 million square feet. Vacancy was cut from 4.1% to 3.1%, resulting in approximately 25% of available space opportunities being taken off of the market. Owners in the industrial asset class have also increased rents, in this case from $0.64 per square foot to $0.71 on a triple-net basis.

The above metrics paint a rosy picture of the market if you’re a landlord, but if you perform a more thorough analysis, there already appear to be signs of an impending slowdown. For example, net absorption of office space in 2014 was nearly 2.3 million square feet, which is 63% higher than the absorption we experienced in 2015. The CEO of Steelcase, one of the world’s largest manufacturers of office furniture, has expressed concern over short-term demand for office furniture. Their data indicates that the nation’s largest companies may curtail their appetite for expansion. There is no question that landlords have been justified in increasing rental rates over the past several years, but where do they go from here?

In last quarter’s newsletter we reported on an uptick in velocity of building sales. Landlords are continuing to make big bets on acquisitions and new, large-scale developments. There is little question that these owners are exposed financially given their long-term investment windows, the sheer amount of capital at risk, and the shifting landscape in the market.

Citing robust demand for space from credit-worthy tenants and no new construction deliveries, owners had an almost irrefutable argument to increase rents in years past. That is beginning to change, as is the reasoning for crazy, double-digit annual rent growth. Once based in logic and data, many landlords have begun to reference single deal points that can be heavily skewed by a myriad of factors or their own “gut feel” of what is forthcoming in the market. Given the level of sophistication of most landlords, this is cause for concern. If there were compelling arguments they would be made, rather than riding the perceptual wave of excellent fundamentals until it comes to a slow halt.

This coming year promises to be an interesting one for tenants and owners alike. Everything from interest rates to elections to global conflict and more will impact how landlords react to maximize their position in the market. The relative illiquidity and almost complete lack of transparency in commercial real estate basically guarantees that most won’t be able to draw parallels between actual performance and the perception of success or failure. Be cautious of hyperbolic claims from landlords and brokers who are unwilling to spend the time to understand the actual conditions in play, and be especially cautious in how you navigate your real estate obligations in this next phase of the cycle.