By Tucker Hughes

It’s official—the 3^rd quarter ushered in a new high for Orange County’s commercial rental rates at $2.56 per square foot for office space and $1.11 per square foot for industrial product. While the highs are new, the appreciation didn’t occur overnight. Over the last several years, we’ve witnessed strong tenant demand pushing developers to build more buildings.

More Space Available

Developers have been racing to deliver new product to cash in on rising rental rates and tenants’ voracious appetite for new space. In the last quarter alone, nearly 400,000 square feet of new development hit the market, bringing the countywide available space to 35.8 million square feet, an availability rate of 13.8%—the highest level since 2014.

Supply v. Demand

In commercial real estate, net absorption represents the demand over a specified period, contrasted with supply. When supply is less than demand, vacancy decreases, and absorption is positive. When supply is greater than demand, vacancy increases, and absorption is negative. Over the prior quarter, Orange County’s annual net absorption turned negative—by 206,000 square feet and for the first time since 2010. In other words, more space was built and added to the market than was leased. Interesting, right?

With an additional 803,000 square feet of new development still underway and pricing at historic highs, the amount of options available in the market will continue to put downward pressure on the rental rates landlords can get from tenants.

Rent Growth Slowing

Rental rates have reached historic highs with continued growth projected for the near term. However, the rate of growth is significantly slowing. Year-over-year rent growth reached double digits of 10% in 2015, but have been appreciating on an annual downward trajectory since then, slowing to 2.5% on an annualized basis last quarter. As new product is delivered and pricing continues to escalate, price-competitive alternatives—i.e. subleases and already-existing product—can become increasingly more attractive. Interestingly, we noticed a slight drop in available sublease space to 4.3 million from 4.4 million the prior quarter, snapping the trend of increasing sublease space we’ve seen for the last three straight quarters. Could this be a correlated event or just coincidence?

The market is thriving and extremely active. Tenant demand is strong and we’re beginning to see a shift in the available supply in tenants’ favor. As landlords’ bullishness eases and options increase (a combination we love!) the next several months will provide some insight on whether this is a new trend developing or simply a rebalancing of variables. Stay tuned next quarter as we see how this all plays out!