How Much Runway Is Left in Orange County?
ORANGE COUNTY, CA—Experts in the commercial real estate industry have been warning of an imminent end to the upward cycle we’ve been experiencing since the recession and the beginning of the recovery. Opinions on just how soon it will end vary according to the market and different sectors within that market. GlobeSt.com spoke exclusively with two of Voit Real Estate Services’ Orange County-based brokers, Doug Killlian, SVP in the Irvine office, who specializes in the office market; and Mike Bouma, SVP in the Anaheim office, who specializes in industrial, to find out where this market stands in their respective sector specialties.
GlobeSt.com: How much runway do you think is left in the current commercial real estate up-cycle in your geographical market?
Killian: There are cycles in real estate that can be identified as recovery, expansion, spec development, then recession. We are definitely well into the expansion phase, in which businesses are optimistic about the future and are adding employees. The market supply begins to thin, and speculative development commences again. We are now experiencing that dynamic, and we will continue to post positive absorption well through 2016.
Bouma: I feel confident we should see continued appreciation in the Orange County industrial market for another two to three years. It is hard to predict further out, but barring any unforeseen events that could affect the national and/or global economy, I’m hopeful to see steady, yet slower, growth for the years following.
GlobeSt.com: When the cycle eventually slows again in your market, do you anticipate it to be a gradual slowdown or something more dramatic?
Killian: Recessions are not ideal, but inevitable. However, our market will be somewhat shielded from the full force, and it will be gradual. One large factor to that statement is we will not be overbuilt with large amounts of product never being occupied, and we will have a much more diversified tenant base than ever before.
Bouma: I don’t see any apparent bubbles forming in the industrial market in Orange County where we would be in for a significant downturn in the market, nor a shift in the supply curve that would result in a glut of product coming on the market, which would lead to a dramatic decline in prices or lease rates. We have a more diversified economy in Orange County this time around that is not likely to suffer from the impact of a downturn in a specific industry type, such as the mortgage-industry implosion and debt crisis that preceded the last recession and had a large impact on Orange County—or like the significant drop in oil prices is having on markets across the nation that are heavily reliant on one industry. Interest rates are also on everyone’s mind, but with the uncertainty in the national and global economies, and with inflation fears not materializing, I’m hopeful the Fed will do what they can to prevent a rapid spike in interest rates, which could have a negative effect on values if increased too quickly.
GlobeSt.com: What are the fundamentals in your market that give it strength when a down cycle hits?
Killian: Quality of life, demographics, diversified work force and lack of available land to overdevelop. Secondly, we have a large amount of local and offshore money just waiting on the sidelines to buy up Orange County real estate.
Bouma: During the prior six years leading up to the recession, there was over 7 million square feet of new industrial product delivered in Orange County. As a comparison, there has been only 2.7 million square feet of new product delivered in the six years from 2009 to present. The Orange County industrial market ended 2015 at a 2.33% vacancy factor—the lowest ever recorded despite 2.2 million square feet of new deliveries since 2014. We have a scarcity of land to build new product, and cities such as Anaheim, Irvine, Costa Mesa, and Huntington Beach are allowing the rezoning of portions of their aging industrial markets to allow for high-density residential projects, further reducing the industrial base. These factors, combined with higher construction costs, create huge barriers-to-entry in our market.
What this means is that even if there is a downturn in demand, it is very unlikely we are going to see a related shift in supply. We have a nice buffer from where we are at now before we will see high vacancy factors leading to downward rents and property values. During the last recession, even with the debt crisis and worry that the industrial market was going to follow suit of the residential market with a flood of REOs, we saw a comparative dribble in the industrial market as lenders negotiated workouts and extensions with many commercial borrowers. We are now selling those properties at or greater-than-pre-recession pricing. All the while, businesses weathered the storm by cutting costs in other ways, strengthening their balance sheets, gaining efficiencies, relying less on bank financing for growth and lowering their lines of credit and maintaining lower loan-to-value ratios on their properties. I think the industrial market in Orange County is generally very healthy, and the businesses within it are as well. All these factors contribute to the strength and resilience of our market.
GlobeSt.com: What else should our readers know about your market weathering cycles?
Killian: Occupancy is everything. Treating your tenants as customers will pay off in the long term; they are the key to weathering the down cycle.
Bouma: We all know that as much as Orange County is an expensive area to do business, it continues to be a great place to live and work. Local-owned businesses don’t want to make a move to lower-priced cities or states, even if it makes economic sense to do so. Proximity to where business owners live is always going to have a factor in keeping industrial businesses solidly anchored in Orange County. Great schools and universities for their families, availability of skilled labor and proximity to the ports are among the reasons that keep industrial-related businesses in Orange County. Although we have seen many of the large manufacturing businesses leave the state or country over the years in order to compete to survive, many companies still retain their headquarters in Orange County, while outsourcing to a manufacturing facility overseas or larger distribution center in areas such as the Inland Empire.