By Tucker Hughes

The Orange County office and industrial markets had remarkably little volatility throughout 2019. The county’s 159 million square feet of office space hovered between 9.7% and 10.1% for the entire year, ending at 10.1%. The average gross rental rate per square foot also remained constant, staying at $2.66 per square foot for nearly the entire duration of the year, which is also where it ended.

It’s worth noting that over the duration of the full year, there was a total of 1.3 million square feet of new office space delivered to the market, the majority of which carries a higher rental rate, which has the effect of pulling the average rental rate across the county upwards, but only slightly. The average reported rental rate is based off of space that is on the market, so even with 159 million square feet, at approximately at 10% vacancy rate, 15.9 million square feet is vacant. Therefore, 1.3 million square feet of product coming online is material, as it essentially is expanding the available supply by just under 10%.

The industrial side of the market was marked with more upward momentum than the office market. After recording a 3.8% vacancy rate in the second quarter of 2019, vacancy dropped to 3.4% by year-end after a strong fourth quarter of leasing. A big contributor to the strength of the industrial market and the decreasing vacancy rates is the lack of new construction that is being delivered. In 2019, there was only 422,000 square feet of new industrial space delivered to the market, which in total is just over 232 million square feet in size. Due to the dwindling supply of land, after the most recent deliveries of space at the end of the year, there is now only 591,020 square feet of product under construction.

The big question for industrial product is how much further can rents go up before tenants refuse to pay them, embracing alternatives in the Inland Empire or South and East Los Angeles, where it is possible to find less expensive buildings? Even with limited future supply and extremely low vacancy, as tenants outgrow their current spaces and are unable to find alternatives, some will be forced out of the market, which is the biggest headwind to vacancy dropping further.

The year ended with the average industrial triple net rent at $0.96 per square foot, which is up from $0.53 per square foot in just 2010.

2020 will be a pivotal year for landlords who are in the process of shaping their forward-looking real estate strategies. On the office side, it’s reasonable to expect owners to get defensive and be more willing to push to retain their tenants and win over new ones, now that there are definitive signs of a flat market. On the industrial side, how far are landlords willing to push rents and where is the threshold where tenants will simply not pay it anymore? Our estimation is that rents cannot be pushed much further, if at all.