O.C. Developers Bet on ‘Spec’ Buildings
Despite rising vacancies and a dimming economic outlook, commercial developers are charging ahead in Orange County, with some putting up office buildings without lining up tenants in advance.
The launch of these so-called spec buildings, at a time when both financing and construction are weakening nationally, underscores the still-vibrant commercial activity in Orange County, considered one of Southern California’s strongest office markets.
But the projects still represent a big and, as some see it, increasingly risky bet by developers. By contrast, developers in the much larger Los Angeles market are taking a more conservative approach, making fewer forays into projects without lease commitments.
Irvine co-developers Starpointe Ventures and Sares-Regis Group said recently that they will break ground in June on twin five-story buildings near John Wayne Airport. The 265,000-square-foot project will cost an estimated $60 million.
“Some of the economic reports we’ve read suggest this is a short-term correction,” said Tim Strader Jr., Starpointe’s executive vice president. “We’re not deterred by the economy or market conditions.”
Neither is Parker Properties, which has begun a 300,000-square-foot expansion of its Summit Office Campus in Aliso Viejo in south Orange County.
“I don’t deny that the economy is going through tougher times right now,” said Russ Parker, a partner. “But the demand for a quality space in places where tenants want to locate is still there.”
Builders such as Parker are looking forward as much as a year from now, when they expect to have their buildings available for rent. They’re betting on a big payoff because fewer developers nowadays are willing to take such risks, meaning that there will be fewer new buildings to compete with them.
In Los Angeles County, new office construction is ongoing in West Los Angeles, Glendale, Pasadena and other select areas, but little is being done on spec, said Richard Schnell, senior vice president at Colliers Seeley International, a brokerage in Los Angeles.
Schnell said one big reason for this is that financing partners, trying to avoid overdevelopment, have been demanding that structures are 50% pre-leased before construction starts. And lately, financiers have become more conservative.
In West Los Angeles, said Schnell, about one-third of the 33 million square feet of office space has returned to the market because of dot-com failures and consolidations.
Potential new tenants, meanwhile, are proceeding more cautiously in expanding. So demand is down too.
But in Orange County, after more than three years of steady growth in commercial building, no one foresees the industry lapsing into a recession or facing the glut of the early 1990s, when there was far more aggressive building. Despite some slowing, economic growth in Orange County remains healthy, and its unemployment rate is the lowest in Southern California.
Most are expecting a drop-off in new construction, from 2.3 million square feet of office space last year to 1.8 million this year. But by historical standards, that’s still robust. Most of that building will be in south Orange County and the airport area.
Still, some brokers and analysts see a softening of the market. Bob Davis, a vice president at CB Richard Ellis in Newport Beach, said his leasing business dropped sharply in January, and he doesn’t see a pickup until the fourth quarter.
Since the end of December, Orange County vacancies have risen 2 percentage points to 11.3%, above the benchmark 10% figure, largely because of additional space added to the market, said Jerry Holdner, who heads the research department at Voit Commercial Brokerage in Irvine. That is the highest rate since the end of 1997.
In the airport area, vacancies also have increased, although it remains at about 10%.
Last year, a record 3.5 million square feet of office space was leased, Holdner said. But recently more companies have been subleasing space they no longer need, he said. With companies waiting for clear economic signs before making plans on new space, competition for tenants will grow keen in key sub-markets, analysts said.
But property owners say they aren’t fretting.
Two larger properties that are currently vacant are owned by Irvine Co., Orange County’s largest landlord. In Irvine, disk drive maker Western Digital Corp. vacated a 15-story, 360,000-square-foot high-rise last month, moving to Lake Forest. Verizon Wireless, a communications firm, withdrew from a 250,000-square-foot space by John Wayne Airport, consolidating into several offices in a 30-acre campus purchased from Irvine Co.
A spokeswoman for Irvine Co., Jennifer Smith, said the company is negotiating with prospective tenants for the vacant office space. She said the company expects the former Western Digital site to be filled with multiple tenants.
As Orange County’s inventory expands, analysts said rental rates may fall from last year’s peak levels. Irvine Co., which typically sets the market’s ceiling for rents, is softening its stance in hopes of filling space, analysts said. That means other developers may be forced to scale back prices to remain competitive, resulting in softer rents throughout the county.
The average office rental rate in Orange County has remained at a record $2.23 per square foot, Voit said, partly because electrical costs that are factored into rents have been soaring, propping up the overall lease payments.
“It’s not as strong of a landlord’s market as it was,” Holdner said. But Starpointe’s Strader and his partners are convinced that a premium location on one of Orange County’s major thoroughfares near John Wayne Airport and UC Irvine will draw interested tenants. An added marketing advantage will be that the buildings will be wired for high-speed Internet access, Strader said.
Campus Centre marks the first time Strader, a former executive at Opus West Corp., and his father, Tim Strader Sr., have developed a commercial project together. The father is a 30-year veteran of the Orange County market and a longtime senior official at Newport Beach-based Koll Co., one of the nation’s largest development firms. The Straders declined to disclose the financing sources, saying only that it is an East Coast company that has previously invested in Orange County.
Strader said that two more office buildings, a hotel, restaurant and more than 500 apartments could be added to the project if the first phase proves successful.
“My gut instinct is that they will get the space filled,” said Barry Gail, a broker at Cushman & Wakefield in Irvine. “But it will be a challenge to fill that space, and for them to get their rates in today’s economy.”
