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Fundamentals Strong, Yet Slowing–A Healthy Pause or Early Indicator?

By Tucker Hughes

We’re officially more than halfway through the year and the Orange County commercial real estate market just wrapped up yet another strong quarter as we head into the summer months with solid footing.

The quarter’s strength is largely attributable to a continuance of strong tenant demand and developer optimism throughout the region as landlords strive to accommodate companies hiring and growth efforts with speculative new development projects. Sustained tenant demand continues to apply upward pressure on rental rates, evidenced by modest upticks in asking rates countywide over the previous quarter. For office space, average asking rates were up to $2.54 per square foot, up from $2.53 per square foot in the prior quarter, and up to $1.08 per square foot which is up from $1.05 per square foot the prior quarter for industrial space.

Despite no deliveries of new construction hitting the market during the quarter, we are starting to feel the effects of previous new product deliveries combined with Broadcom’s giveback of 1 million SF to the market as the glut of supply applies downward pressure on rental rates and upward pressure on vacancies. The total available space countywide (combined office and industrial product) increased to 35.7 million SF up from 35.5 million SF from the prior quarter, moving the countywide vacancy rate to 5.0%, up from 4.9% the prior quarter.

Office availability increased to 9.9%, up from 9.8% the prior quarter, as vacant sublease space increased 12% despite a nearly 10% drop of vacant direct space available from the prior quarter. Similarly, industrial availability saw a slight uptick to 2.4%, up from 2.3% the prior quarter as a result of over 250,000 SF of new sublease space hitting the market.

Strong demand and steady rental rate appreciation are signs of a healthy real estate market. A closer look under the hood reveals that despite positive indicators, the rate at which the market is growing is slowing down. The annualized rate of growth for office rents slowed to 3.7% on a year-over-year basis, down from the 4.8% year-over-year rate of growth in the prior quarter, with industrial rates at 5.8% annualized growth rate versus 6.7% from the prior quarter.

Further, total available sublease space is hovering at 4.4 million SF, 20% higher than the five-year average. Increasing amounts of sublease space can act as a canary in the coal mine indicating a softening market if it is the result of companies downsizing or going out of business.

Orange County’s various submarkets are increasingly telling different economic stories as shifting demographics are reshaping the local economic hot spots. Airport Area, for example, continues to be the softest submarket throughout the region, accounting for nearly 19% of available space on the market, despite head-spinning demand and a flurry of recent activity to backfill Broadcom’s old campus at UCI Research Park. South County, on the other hand, accounts for nearly 12% of available space, as a result of Irvine Spectrum’s allure, which is helping to attract top companies and talent for its live, work and play appeal.

This slowing rate of appreciation combined with a growing inventory of available sublease space is a bit concerning and consistent with our reoccurring themes we’ve noted in our previous recent market reports. Hopefully the resiliency of our local businesses will prove these indicators to be false positives as we continue to chug through the rest of the year and beyond. The local economy is doing great and businesses across all industries are investing capital to hire and grow their business, signaling confidence and optimism in the future. It’s natural for a strong market to take a breather like this—it’s healthy. Sometimes the market has to slow down a bit to recharge before it can come back even stronger. Just in time for summer.

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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