OC Momentum Slowed During 3rd Quarter

The Orange County industrial market closed the third quarter with net absorption recording negative movement at -174,400 square feet. Although demand was negative for the quarter, market conditions are expected to continue to tighten. Industrial product continues to deplete as many properties are being sold for multifamily redevelopment or creative office space conversion. This is especially true for the industrial inventory located in the Irvine and Newport Beach market areas, with demand outweighing supply. Given the lack of relocation space options, tenants are renegotiating their lease renewals 18-24 months prior to their lease expirations.

The total vacancy rate in the third quarter increased 10 basis points from last quarter to 2.3%. Space remains scarce in Orange County, with the availability rate at 3.8%, down from 4.1% one quarter ago. Vacancy is tightest for buildings up to 9,999 square feet and between 70,000-99,999 square feet at 1.6%, while buildings 100,000 square feet or greater have the highest vacancy rate at 2.8%. The Orange County industrial market recorded negative movement as net absorption recorded -174,400 square feet. Much of this negative absorption stemmed from the Airport Area (-283,000 square feet) submarket. The biggest leases of the quarter were Kuehne+Nagel renewing 300,000 square feet deal in Anaheim, Safety Zone signing 143,970 square feet in Buena Park and Kusha Food renewing 116,975 square feet in Cypress. The weighted average asking rental rate for Orange County recorded at $0.91 PSF NNN, up 6.0% from the $0.87 reported one year ago. Rents have steadily risen over the past three years as industrial tenant supply options remain limited. Average asking rates were highest in the South County submarket at $1.11 PSF NNN and lowest in the West County submarket at $0.80 PSF NNN.

During the third quarter, no new buildings were delivered to the market. Three industrial projects are currently under construction totaling approximately 1.3 million square feet. The Beckman Business Center project, which consists of seven buildings, totaling 934,754 square feet, is expected to be completed by the end of 2018. Investment volume for industrial properties in 2018 increased by 24.0% compared to the same time last year. Year-to-date sales volume  recorded at $806.2 billion compared to $650.2 billion one year ago. Rising sale prices led to a further compression of cap rates to 4.6%.

Key Takeaways:

  • The vacancy rate increased by 10 basis points to 2.3% during the third quarter. Vacancy stood at 2.7% one year ago.
  • Asking rental rates increased 4.6% from one year ago to $0.91 per square foot (PSF) triple-net (NNN).
  • Industrial demand recorded -174,400 square feet of net absorption. Much of this negative demand was concentrated in the Airport Area submarket.
  • Construction activity increased, adding one new project during the third quarter totaling approximately 1.3 million square feet.
  • Although demand was negative for the quarter, market conditions still remain tight and quality industrial space is scarce. Asking rental rates are expected to rise an additional 2%-3% by the end of 2019.
     

Outlook:

Despite positive market fundamentals, tenants are struggling to find future space options to meet their needs given the lack of available inventory. Demand remains strong for larger e-commerce companies. Online retail has grown from 3.5% of all retail sales in 2007 to 9.6% of all retail sales currently. The pace of this growth has not slowed and will continue for the foreseeable future as consumer preference continue to evolve. As internet retail continues to grow, so too will the need for supporting industrial space.

With 1.3 million square feet of space under construction and strong industrial demand, vacancy rates are expected to remain at historic lows. Net absorption is expected to show positive movement in North County due to the future delivery of the Beckman Business Center Development in Fullerton. Asking rental rates are expected to trend upward by 2-3% by the end of 2018 due to lack of supply. Development is a challenge in Orange County as many industrial properties and remaining development sites are being converted to residential and other commercial uses. Investors remain attracted to the industrial sector due to continued shifts in consumer behavior and growing economy. Southern California remains the premier industrial investment market given low vacancy rates, rising rental rates and close location proximity to the ports.