By Tucker Hughes
In our last quarterly report we explored the spinning of landlord data to create the appearance of increased market demand. Net absorption for the county in 2015 was positive and appeared impressive on the surface, however, it represented a precipitous slow down relative to previous years. Now, for the first time since 2010, we are seeing substantial negative absorption throughout the county’s office portfolio, with 535,000 square feet of space already coming back to the market.
For some perspective, total office space absorption for the county in 2015 was 1,165,000 square feet. Based on this metric, the first quarter of the year has eliminated half of the progress made in all of 2015. A similar story is being witnessed for industrial property as well, though the numbers are not nearly as extreme. Even the core office markets are experiencing challenges, yet major landlords won’t admit this publicly.
Our team is actively representing upwards of 150 companies throughout Orange County in the evaluation of their real estate options. This typically manifests itself in working on requirements that will commence six to 18 months from now, allowing for a unique and real-time perspective on the market. It is apparent that large owners of real estate are bolstering their defenses by agreeing to early, cost effective transactions that stabilize their portfolios. While this is certainly not how they frame their “creativity” when it comes to deal structuring, it is apparent that many are becoming increasingly concerned by what they are seeing in the market.
Given this general sentiment and landlord concerns about being able to increase rents further, there has been a drastic slowdown in building sales. Consider what it takes to have a successful acquisition as a buyer of commercial real estate. One either needs to buy at a favorable cap rate (yield) and sell with a higher multiple, or increase rents through value add improvements or the general movement of the market. In a low interest rate environment it is a near certainty that buildings will be sold to the next buyer at a higher yield than what is offered today, pushing down purchase prices. With rent growth slowing, investments with a margin of safety will be difficult to find.
On a more positive note, there are still businesses actively in expansion mode in Orange County, an example of which is WeWork, a rapidly growing company recently valued at $16 billion that operates the most desirable co-working spaces one can imagine. We represent WeWork throughout Orange County and look forward to a successful opening of their first location at 200 Spectrum Center Drive this summer. Those considering co-working space would be best served by securing space sooner rather than later, as strong demand will likely result in the material pre-leasing of opportunities.
Expect 2016 to be a year of less rapid rent growth and possibly a slight retraction as the market heads towards equilibrium. While it is not expected that the tide will turn in favor of it being a tenant’s market, changing conditions will undoubtedly slow down or even halt further appreciation.
Tucker Hughes is managing director at Hughes Marino, an award-winning commercial real estate firm with offices across the nation. As head of Hughes Marino’s Orange County and Los Angeles offices, Tucker specializes in tenant representation and building purchases throughout Southern California. Tucker makes frequent media appearances to speak on the future of commercial real estate, and is also a regular columnist for Entrepreneur.com. Contact Tucker at 1-844-662-6635 or email@example.com.