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Strong Third Quarter Paves the Way for Low Vacancy Rates

By Tucker Hughes

The third quarter of the year was a strong one for both the local office and industrial space markets. Both asset classes experienced significant absorption (a reduction in the total amount of available space) and rental rate growth. The total size of the Orange County office market is 154 million square feet, comprised of three different general groupings of buildings based on quality. The first grouping, Class A, being the nicest, represents 46 million square feet. The second and third groupings are progressively less luxurious, and represent 86 and 22 million square feet, respectively.

The absorption noted earlier primarily occurred in the Class A segment. For example, consider that of a total of 627,000 square feet of absorption, over half of it, for 323,000 square feet, was in the Class A classification. This represents 52% of the total absorption across only 30% of the total square footage in the market. Given that the vacancy levels of each of the three classes are at 11.8%, 8.6%, and 4.4% for A, B, and C, respectively, it makes sense that we are experiencing increased demand for a product that has more availability. Simple supply and demand would dictate that over time higher vacancy product types would offer better value on a cost/quality basis.

While vacancy rates may seem moderate, it can be concerning to back into the rates at which available spaces are evaporating. The total amount of vacant space for Class A, B, and C product types are 5.4 million, 7.6 million and 1 million square feet. Between the second and third quarter, we saw the amount of available space in each of these sectors reduced by 5%, 3%, and 6%, in a single quarter. Imagine if this was extrapolated for an annual period… a total reduction of available Class A office space of 20% would have an enormous impact on rental rates. Landlords see this micro level data and will look to make use of the continued leasing momentum in the market.

The good news is that there are some substantial projects on the horizon, with a total inventory of 2.4 million square feet of new office product under construction. Rewind to early 2015, when landlords were strategically acquiring properties that had large blocks of available space, recognizing the desire for large companies to have their people under one roof in this market and limited supply of opportunities. Now it appears that there will be a huge surplus of large blocks of space available in the near future. Between Irvine Company’s 470,000 square foot high rise under construction in Irvine Spectrum, the 540,000 square foot Boardwalk development on Jamboree, and Broadcom’s Great Park and University Research Park campuses all having big blocks of available space to lease, many of these landlords are going to be forced to lease to smaller tenants than originally planned.

The industrial space market is as tight as ever with a vacancy rate of just 2.4% and only 312,000 square feet of inventory under construction countywide. Last quarter we saw 785,000 of positive absorption for the industrial asset class, an amount that would wipe out all new construction and then some. In fact, a lot of inventory over this past year in more urban areas has been eliminated in favor of building higher density uses such as office and multi-family product. Due to the price of land, it will become increasingly challenging to develop industrial buildings at reasonable prices relative to building in the Inland Empire.

With all of the activity and momentum in the market, it will be interesting to see how both tenants and landlords alike react. Will they temper their expansion plans in favor of a more conservative approach or continue to build and lease while times are good? Only time will tell.

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 tucker@hughesmarino.com.

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