Vacancy Rates Heading Up

The office market in Orange County is off to a rocky start this year. According to research from NAI Capital, the office vacancy rate ticked up 80 basis points in the first quarter to 9.7%—the biggest increase in Southern California. While the numbers are nominal, the office vacancy rate has been slowly ticking up since the first quarter of 2017, and Joe Faulkner of NAI Capital expects the supply to continue to grow this year. A combination of new product deliveries, the redevelopment of older product and the rightsizing trend is driving the increasing office supply in the market.

“There is no underlying, overarching principal,” Faulkner, executive managing director of NAI Capital’s Downtown office, tells GlobeSt.com about the trend. “Orange County had the biggest jump in vacancy rate, but the market had a lot of new product come online. The Spectrum area has had a lot of office development that has been preleased, and the Airport Area has suffered a little bit as a result.”

While the new office development has been a contributor to the growing vacancy metric, an increase in sublease space has also begun to impact the direct leasing market. “One thing that portends some caution in the future is that more sublease space has hit the market,” says Faulkner. “More companies have oversubscribed or are in the process of rightsizing or downsizing based on the fact that they are using a lot less square footage per employee. Orange County has had come massive swings in sublease space. When the market collapsed, 26% of the space around the Airport were mortgage companies, so it collapsed and has slowly crept its way back.”

While creative office tenants are rightsizing and adding to the sublease supply, the creative office segment of the market is seeing substantial leasing activity. As a result, value-add office projects have become ubiquitous in the market. Faulkner uses the example of the Met, a three-building creative office conversion project from McCarthy Cook & Co. in Costa Mesa. “The owner repurposed it and made it creative,” he explains. “It is going gangbusters lease-wise, and it is like new space coming on the market because it was such a forgotten project for so long.”

With plenty of aging office supply to redevelop and the increasing cost of construction, Faulkner expects new, ground-up office construction to slow—and that could be good news for the office vacancy rate. “The cost of land and the construction has really increased,” he says. “If you are going to build a ground-up office building today, the rents you need to get might be 20% over where they are today. So, no one is doing it.”

According to the research, the total office vacancy rate in Southern California is 10.2% over last year, and increase of 20 basis points.