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Orange County Quarterly NewsletterOCPERSPECTIVE

Orange County Office: A Golden Opportunity for Investors?

Medical Office Trades Hands for $7 Million in Aliso Viejo

Written by Jared Dienstag, Regional Research Analyst for Colliers International in Orange County

Since 2004, the Orange County office real estate market has been challenging to follow and even harder to predict. It began with strong sales activity and lightening quick sales price appreciation, which made Orange County one of the nation’s darlings for commercial real estate investment. But just as quickly as investors were outbidding one another for Class A office properties, the bubble burst and many opportunistic landlords were stuck with overpriced properties. As the recession gained momentum, large companies began going out of business, leaving behind significant

blocks of vacant office space. With rising vacancies and declining rental rates, some property owners who acquired office buildings from 2004 to 2007 were forced to sell or give their buildings back to lenders.

Office Market Distress

Due to the aforementioned conditions, Orange County is the most distressed high-image office market in Southern California. Even the nearby top-tier office markets of West Los Angeles and Downtown Los Angeles have only witnessed a small amount of distressed properties. “After a somber period of low sales activity, investors are now starting to take advantage of the accumulating surplus of high-image

Colliers International directed the sale of a 27,000-square-foot medical office building located at 24502 Pacific Park in Aliso Viejo, Calif., to Accretive Realty Advisors, Inc., an Irvine, Calif.-based real estate investment and advisory firm specializing exclusively in medical office space. The transaction is valued at $7 million.

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Executive Corner -

Expert Column -

OC Top Deals -

Colliers Market Watch -

Colliers New Look -

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SummeR 2010

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Prospects of a Double Dip Recession

Opportunity for InvestorsMedical Office Trades Hands

Talk of a double dip recession has been circulating since economic growth began to slow in the second quarter of 2010. While no one knows for certain if

this second recession will actually take place, prospects of a double dip can be viewed from both a national and local perspective.

At a macro level, all eyes are focused on whether or not the federal government will institute a new stimulus package. Although this would throw a life vest to the economy, it could also mask whether or not it is

strong enough to stand on its own two feet. The continued lack of available lending is another area of serious concern. Despite sizable growth during the first quarter of 2010, small businesses struggled due to the lack of available lending.

On a local level, the housing market has long been a key to Orange County’s economy. The recent and ongoing fluctuations of the housing market make it difficult for businesses and consumers to get a clear reading. Sale prices are inconsistent and the number of foreclosures flooding the market remains high. The health of the housing market plays into another key factor – unemployment. During the boom years, Orange County’s labor pool

depended heavily on the real estate industry for employment. The County lost 10,300 jobs in the month of July and unemployment climbed upward to 9.8%.

Unless new economic drivers and business sectors initiate a sustainable cut into unemployment, the economy will continue to suffer. Right now only one thing seems to be clear, government and businesses must quickly get on the same page in order to prevent the economy from slipping into a double dip recession.

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Martin PupilRegional Managing Director, Greater Los Angeles

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Built in 1987, the 27,000-square-foot medical office building is leased primarily to Kaiser Permanente, which occupies two of the building’s three floors. The other floor is occupied by several local physician groups.

“Despite the tough market for investment sales in general office product, there is still strong demand for medical office buildings from the investment community. We have found that investment groups with an extensive medical background have been successful in identifying and structuring value-added medical plays, despite the difficult economic backdrop. These groups have been increasingly active in assembling medical office portfolios over the past 12 months,” said John Wadsworth, vice president and director of healthcare services in Colliers International’s Irvine office.

Wadsworth, along with Bob Hoyt, senior vice president in Colliers International’s Irvine office, represented both the buyer and the seller, Saunders Property Company, a Newport Beach, Calif.-based real estate investment firm.

distressed office product in Orange County. In recent months, several sizeable distressed office properties sold in the airport and central submarkets,” said Martin Pupil, regional managing director for Colliers International’s Greater Los Angeles operations.

Class A office properties recently sold at a loss include 3161 Michelson Drive in Irvine, 3501 Jamboree Road in Newport Beach, 3 MacArthur Place in Santa Ana, 2050 Main Street in Irvine, 5 & 6 Hutton Centre Drive in Santa Ana and 505 &

600 City Parkway West in Orange. In addition, several office buildings have been given back to lenders, most of which were part of Maguire Properties’ (now MPG Office Trust, Inc.) Orange County portfolio.

Opportunities Unveiled

For new landlords entering Orange County’s office market, the significant amount of distress has been a gift. Class A properties that traded for a premium during peak years are now being nabbed up by new investors at severely discounted prices. These investors are in a prime position to lease up their buildings as the market turns around and will eventually have an opportunity to sell these assets for a strong return on investment.

^ 2050 Main St. in Irvine was sold for $56 million ($178 PSF) in November 2009.

Opportunity for Investors

Have we reached a good time for apartment investments? While local apartment market fundamentals have stabilized and show promise, there are “two elephants in the room.” Positive indicators include stabilizing employment, positive net absorption, relatively little new construction, steady vacancy and declining concessions. With that said, job growth remains anemic and over-leveraged housing debt continues to burden the economy.

Orange County added about 37,000 new jobs in 2010 and the weaker Riverside/San Bernardino markets also show signs of employment stability. This follows more than 250,000 job losses in these counties in 2009. Not surprisingly, new hiring is happening more so in densely populated areas, so it’s likely that Orange County and Western Riverside/San Bernardino locations like Ontario, Corona and Rancho Cucamonga will lead future growth.

The local markets have also been able to positively absorb new inventory. According to REIS, Orange County absorbed almost 1,750 apartments, exceeding the 1,639 units constructed. Most new inventory is located in Irvine, Anaheim and Brea. New construction in the Riverside/San Bernardino markets is already down 60 percent compared to the five-year average. All three counties will have little new construction in 2011. In short, positive net absorption, combined with nominal construction, will move supply and demand towards equilibrium. Orange County’s vacancy is already a relatively healthy 6.4 percent and Riverside/San Bernardino is 8 percent, down 0.4 percent over the last six months.

It’s reasonable to speculate that we’ve turned the corner. However, one must consider two mitigating issues – job creation and household debt. While job losses have bottomed, the sectors of construction and mortgage-related finance employment may take years to come back. Over-leveraged housing also remains a huge issue. Riverside/San Bernardino ranked the 4th MSA among the nation’s 206 metro areas in foreclosure. Orange County is better, but still the 35th-highest foreclosure rate in the nation. According to research company CoreLogic, 33 percent of California homeowners have mortgages exceeding home value. Almost 60 percent of Orange County home sales are short sale situations. Although the single-family market doesn’t directly impact the multifamily market, there is linkage including shadow-vacancy of homes for rent, inability to sell homes and relocate into rental housing, and weak credit quality among the general population.

In summary, the vital life signs of the multifamily housing market have become stable and recovery is hopeful, albeit likely at a slow pace. Some major multifamily investors, such as Washington, DC-based Avalon Bay Communities, Inc. are active acquiring local multifamily assets. Rent growth and appreciation will take time as job growth remains sluggish, household credit tight and the single-family market resolves its workout. Still, while the sun may not be shining, it appears to have stopped raining.

Expert ColumnApartment Market Shows Some Promise

“For well-located assets there is a range of financing available that would make purchasing in this part of the market cycle attractive to seasoned buyers with a proven track record. Banks are eager to lend at interest rates that are low by historic standards to investors who are bringing fresh equity to the table with an executable business plan,” said Mark Strauss, managing director for Cohen Financial.

Even with the recent relatively high sales activity, there is no reason to believe that the sale of distressed properties will subside. In fact, there are at least a dozen Class A office buildings purchased from 2004 to 2007 with high vacancies that may not be generating enough cash flow for landlords to pay off their loans. As a result, these landlords could be forced into selling or giving the assets back to the lender.

This is particularly noteworthy for investors who have been interested in entering the Orange County market as office landlords for quite some time. Recently sold buildings have attracted multiple bids and it is expected that future Class A distressed office properties will be a magnet for investors who wish to own high-image assets in an upper-tier market.

Now is the Time

Based on the high level of interest in Orange County, it is evident that investors view this market as a viable long-term investment due to the geographic location and highly-educated labor pool. The considerable number of projected transactions involving Class A office properties will further cement Orange County as the Southern California epicenter of distressed office assets. Potential investors must start their research and due diligence sooner rather than later on properties they are eyeing for acquisition. In some instances, available properties are not always accompanied by a full marketing campaign, which might be the case for buildings in danger of being sold at a loss or being seized by the lenders.

“In a market of traditionally high barriers for entry, current market conditions are producing what could be seen as once-in-a -lifetime investment opportunities. For anyone who has been interested in owning Class A office properties in Orange County, now is the time to take advantage of the discounted sales prices,” said Pupil. *This article was published in the July 27, 2010 Issue of Orange County Business Journal.

William J. Drewes is valuation services director for Colliers International Valuation & Advisory Services (FirstService PGP) in Colliers’ Irvine Office.

Accelerating success.

Residential Land Sale Santa Ana

4.7 Acres ›Undisclosed Price ›Stephen Schloemer ›

Apartment Sale San Clemente

9 Units ›$4 Million ›Patrick Swanson ›

Industrial Lease Huntington Beach

167,778 square feet ›$4.9 Million ›Clyde Stauff ›

Retail Sale Huntington Beach

7-Eleven Anchored Center ›$1.6 Million ›Mehran Foroughi ›

Colliers International Orange County

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Colliers Market Watch

Colliers New Look

OFFICENet absorption during Q2 was -455,500 SF as the office market ›

witnessed further space givebacks. However, the amount of space givebacks was significantly smaller than the previous quarter which reported an amount of -1,000,800 SF.

The weighted average asking rental rate at the end of the quarter › was $2.08 PSF per month FSG down from $2.13 PSF (-2.3%) reported last quarter and from $2.37 PSF reported one year ago (-12.2%).

Leasing activity for Q2 totaled 1.7 million SF, up 26.3% from the › 1.35 million SF of leasing activity reported last quarter, but down 3.6% from 1.77 million SF reported one year ago.

INDUSTRIALSales and leasing activity reported a decline from last quarter to 3.06 ›

million SF. Despite sales and leasing activity decreasing from the

previous quarter, the amount reported is higher than any quarter from 2009.

The total vacancy rate, including sublet space, increased 10 basis › points from 6.3% reported in Q1 to 6.4% in Q2.

The weighted average asking rental rate declined to $0.60 PSF per › month, Triple Net (NNN) from $0.62 PSF reported in Q1. Since last year, the average rental rate has decreased 11.8% from $0.68 PSF. Weighted average asking rental rates are the highest in the South submarket ($0.77 PSF) and lowest in the North submarket ($0.50 PSF).

ECONOMYUnemployment was at 9.8% as of July 2010. This is a slight increase ›

from 9.7% one year ago.High unemployment and uncertainties in the housing market are ›

preventing consistent growth from occurring in Orange County.Commercial real estate fundamentals continue to decline, but at a ›

slower pace than what took place in 2009.

If you’re wondering why this newsletter looks different from past editions, it’s because we’ve updated our look! Colliers’ new, modern logo and graphic elements were specifically designed to support the recent integration of Colliers’ services under a single enterprise, which includes a shared vision, single name and consistent service offerings to our clients.

Our new, single-brand enterprise was established in response to client requests for more accountability, deeper specialization and access to a broader range of markets. With a commitment to exceeding our clients’ expectations, under a single brand we are more aligned as an organization and foster a culture where each one of us plays an integral role in accelerating your success.

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