Expert Says Too Much Office Space Exists in County
Alfred Gobar is wearing an open-necked knit shirt and slip-on shoes, but don’t be misled by the casual attire. It’s the middle of a Friday morning, and Gobar has already had several lengthy telephone conversations with clients, pored over a stack of computer printouts and sent billows of pipe smoke rising to the ceiling of his small office. He’ll work through the afternoon and then be back in the office, he says, before 6 a.m. the next day--a Saturday--and maybe on Sunday as well.
“You could lock me up in this office with a bunch of statistical reports, and I’d be happy,” he says.
Gobar is a nationally known consultant to the real estate industry. From a sunny suite of offices in the old section of Brea, he runs Alfred Gobar Associates, a 12-person firm that he says has had as much business as it can handle for the last seven years.
Gobar cranks all the information in those printouts into a computer, and out comes a recommendation on what types of houses will sell in a certain neighborhood or an assessment of the likelihood of a new shopping center doing well on a particular corner.
Among the names on a long list of Gobar’s clients: mammoth developers like the Irvine Co. and Rancho Mission Viejo, lenders like California First Bank and American Savings & Loan Assn. and a number of cities, including Chicago, Los Angeles and Miami.
Gobar, 55, is a blunt but amiable man who earned a master’s degree in history from Whittier College and a Ph.D. in economics from USC. He lives in Fullerton, a short commute from his office.
In this conversation with Times Staff Writer Michael Flagg, Gobar talks about recent trends in commercial real estate in Orange County.
Q: According to a recent survey, about a fifth of the space in Orange County’s bigger office buildings was vacant in the third quarter. How serious a problem is that?
A: It’s going to take a long time to absorb all that space, because at 20% you’d have to have a pretty good economic growth rate to burn it off and get down to a 5% or 6% vacancy rate in a reasonable period of time. Meanwhile, we’re continuing to develop new office space at a rate faster than our local economy is growing, which means we’re going to have a very competitive office market for quite a long time in the future.
Q: Why is the vacancy rate so high?
A: Typically in the office market, the beginning of a cycle begins with a low vacancy rate and the market in good shape, because previous overbuilding cut off new development for a long time and most of the empty space got filled.
But lenders tend to have long memories, and at the beginning of the cycle they’re very tentative about making loans for office construction. So it’s hard to build at the time you should build. Then those projects that are built do well and the rents go up and lenders get more confidence. They get their highest level of confidence near the end of the cycle, when there’s already a lot of new development in the pipeline. For some reason, people get confidence in seeing a lot of other buildings being built.
To me, of course, that’s scary, but to other people it’s a positive sign when somebody else is building a building. They think: “There must be something they know that we don’t know.” But chances are there isn’t.
Q: Are there any building owners in financial trouble out there because they’re having a tough time finding tenants?
A: I don’t think there’s too much danger of major financial problems in the office sector, because the pattern here is for the developers who build the big buildings to have a major financial institution as a partner. The institution puts up the money and the developer puts up the expertise, and they split the equity on some negotiated basis.
Many of those institutions are so huge that that they can stand a sub-optimal return on investment, because it’s mitigated by return on investment on other assets they’ve had for a long time.
So there’s not, therefore, the financial disincentive to build, as it would be if you and I were putting up our own money, and if we build an office building that didn’t lease, we would have to kick it back to the bank.
Q: How long do you expect this oversupply of office space to last? Will vacancy rates go higher still?
A: It’s really hard to estimate, but I would say that the vacancy rate will probably get a little higher before you begin to see people pulling back, probably in the next year. I’m surprised they haven’t pulled back sooner. And when they do, it’s a question of how much inertia there is in the system. Even if they stop doing new projects completely, there would still be buildings already under way you’d have to consider, and that makes it hard to estimate.
Q: With office buildings in many urban areas running fairly high vacancy rates these days, the Orange County vacancy rate of 21% in the third quarter isn’t that much out of line, is it?
A: No, it’s not. It’s just that the whole industry has been typified by a high level of interest in development of office buildings. We had demand for office buildings nationwide increasing much faster than the general economy from say 1972 until about 1983 or 1984. It’s still increasing faster than the general economy, but at a much diminished pace.
Q: Let me ask you the obligatory question: Is October’s stock market crash going to have an impact on real estate?
A: The facilitator for real estate development is the inflow and availability of money, not necessarily the market. If there’s money, developers will build with it. And so I don’t see that the crash is going to have an immediate impact, except for the psychological concern.
For instance, a small businessman who worries about the stock market might say: “Well, instead of moving into new offices, I’ll stay where I am because my rent’s more moderate here.”
But as a matter of fact, in today’s market, new office buildings are not that much more expensive to rent than old ones because of the concessions that are being made to get people to move in.
Q: Are a lot of concessions being handed out in Orange County office markets?
A: Oh, there are some huge, huge deals. We recently evaluated a lease for a major tenant in terms of what the give-ups were to get him into the building. He’d be the first pickle out of the jar in a big building, and he was going to take a lot of space, and the giveaways added up to about $5 million.
Frequently now, major tenants can negotiate to move into a building and also get a piece of the equity of the building while they’re also getting major concessions, particularly the biggest tenants.
Q: Are those kind of equity deals for tenants becoming more common in Orange County?
A: Yes.
And the concessions are still fairly attractive too. In a high-rise building in the market study we just finished, if you sign a five-year lease they’ll give you 12 1/2 months free rent. It’s basically 2 1/2 months per year of lease. So it’s 20% free rental, which is a rent reduction of 20%, no matter how they space out the freebie.
Q: As down as the office market is right now, why does the apartment market seem to be doing well, judging by vacancy rates?
A: Apartment vacancy rates are fairly low for a number of reasons. The biggest is that it’s very hard to build houses in Orange County, very hard to get entitlement to build housing, partly because of the no-growth movement.
As a result, the price of land that’s developable for housing has gone up very rapidly, because you have to pay the land owner quite a lot--not so much for his land--but for the fact that you can get away with building something on it. And if you raise the land price, you have got to raise the cost of the houses.
So we’re in a period where only a third of the people in Orange County can qualify to buy even resale houses. And we’ve pushed a lot of potential home buyers into apartments because they’ve got to live somewhere.
Q: I assume that, in turn, makes for high rents?
A: It keeps the vacancy rate in apartments very low and, as far as rental rates in apartments, they go very high. We’re looking at some rental rates as high a $1.50 and $1.45 a square foot, which is incredible, you know. It’s more than some office rents in a suburban office building.
I don’t see any way that our supply of housing is ever going to catch up, particularly if the no-growth initiative goes through. But even if it doesn’t, we’ve had too many impediments to development of cost-effective housing to respond to the full spectrum of the market.
Q: You’ve described what’s going on with industrial buildings these days as an “artificial shortage.” Would you explain what you mean?
A: The process I was describing was when we had a shortage of office space in the late 1970s and we had a surplus of industrial space at the same time.
In order to rent the industrial space, owners, in essence, converted it to offices by dropping the ceilings, putting in air conditioning and landscaping. And they got rents much above industrial rent and still below office rents.
That attracted other investors, who said: “We can take an industrial building, and all we do is spend a little bit more money on tenant improvements, a little bit more on design, a little bit more on landscaping, and get a lot more in rent.”
They called it R&D; high-tech space, which doesn’t have a hell of a lot to do with the tenants because they’re not all R&D; high-tech firms exclusively by any means. That in turn caused the people who owned industrial land to attach a higher value to their asset: The developer can pay more for it because he gets higher rents for what is essentially only a somewhat upgraded building. So that restricted the availability of land for plain old vanilla industrial space, with the result that the rents for plain vanilla industrial space went up pretty fast. That froze some potential tenants out of the market, because many tenants for industrial space are particularly rent-sensitive; they operate on thin profit margins.
Q: This contributed to the slowdown in local factory employment economists have been warning about?
A: Well, we found that not all the rent-sensitive manufacturers go; some of them pay the higher rents. But our industrial base is not growing as fast as it used to, for a lot of reasons.
One key reason is that it’s getting hard to get the bodies in here to go to work, because the blue-collar labor base increasingly is in Riverside and San Bernardino counties. And the freeways are getting more and more congested, and so there’s a very slow migration of factories out of the county.
But that migration is impeded by the reluctance of the head man to have a plant very far from where he lives. And in many cases he’d really much rather not live in the Inland Empire yet, so there are some countervailing forces involved.
Q: In light of all this, what’s the outlook for Orange County’s economy over the next four to five years?
A: Well, we’ve been historically pretty immune to recession. Since 1965 we’ve only had one year in which there was a decrease in employment in the county on a year-to-year basis. And from 1970 to 1980 we averaged over 40,000 new jobs a year.
Of course, if there’s a national recession, we’ll obviously have a slower rate of employment growth here. We may actually have a downturn.
But the only industry we have locally that is sensitive to recession is the construction industry. A lot of construction firms are headquartered here, and the real estate industry is very cyclical anyway. But that’s the only one of our economic base elements that’s really dramatically exposed to recession.
Q: What makes the county’s economy so resistant to the effects of recession?
A: It’s diversified and it’s new, so we don’t have a Bethlehem Steel mill and we don’t have the kinds of industries that are capital-goods related, which have a special sensitivity to recession. The nature of our manufacturing industries has not been centered on steel, the auto and so forth, the industries that have historically been especially sensitive to recession. When we have a recession, our manufacturing gets hurt, but it doesn’t get hurt nearly as severely.
