Over the last several years, investors
have been bidding up San Diego commercial properties with reckless abandon. And every time it looks like the
party may be over, along comes another
investor, willing to pay even more.
Enter the Irvine Company, a savvy real
estate company with a history of owning
and maintaining quality office buildings
throughout Orange County. In May, Irvine
purchased Equity Office Properties San
Diego portfolio including 15 buildings within the University Towne Centre (UTC) sub-market. Now in escrow on another eight
office properties at Bridge Pointe
Corporate Center, Irvine is poised to control the lion’s share of the UTC Class A
office leasing market. And this in addition
to their dominant market-share already
assembled in downtown San Diego.
So what does it mean when The Irvine
Company drives down the freeway to play
“Monopoly” with San Diego’s best office
buildings?
“The Irvine Company is different from
other institutional investors,” says John
Jarvis, a principal and senior vice president
with Irving Hughes. “They have tremendous free cash flow, little or no debt, and a
massive portfolio of fully depreciated
office buildings throughout Orange
County. I don’t think they even try to calculate an IRR when they buy these buildings.
I think they are happy to have found a
place nearby to reinvest their Orange
County earnings.”
Smart Business spoke with Jarvis about
the Irvine Company’s move into San Diego.
Why are so many people concerned about
the Irvine Company’s recent investments in
San Diego?
There has been a lot of talk lately about
record high prices being paid by institutional investors for San Diego properties.
The Irvine Company is a natural lightning
rod for that attention for two reasons: volume and price. Since 2003, Irvine has spent
close to $2 Billion in San Diego. Their targeted purchase of Class A office properties
will put them in a position to control over
62 percent of the Class A leasing market in UTC and 58 percent of downtown. In addition to the sheer volume, Irvine continues
to pay top dollar for quality properties, setting record high prices on many of their
purchases. Pacifica Tower in UTC is estimated to have sold at $572 per square foot.
Never in the history of San Diego has one
landlord made this kind of play and had
this kind of concentration of ownership in
our Class A office properties.
Why is this creating anxiety for San Diego
companies?
At the end of the day, the Irvine Company
is a smart real estate investor. And there is
only one way that Irvine, or any other real
estate investor, earns a return on these purchases, and that return is from the office
rent that our clients pay.
So companies are expecting Irvine to raise
rents?
Yes, everyone expects Irvine to raise
rents. But it’s no slam dunk. We have been
vocal in the local press about the dysfunction in the commercial real estate market
today — the lack of solid market fundamentals, such as robust job growth and positive net absorption that could justify
this unprecedented investment activity.
Instead, we see rampant speculation, with
institutional investors trading buildings at
ever-increasing prices predicated on ‘proforma’ rents that may or may not ever be
realized. And here is the key point that people are missing: Whether we are talking
about the Irvine Company or any other
investor, just because an investor pays a
high price for their property doesn’t mean
they can raise your rent. It doesn’t work
that way.
Then what is going to happen?
Econ 101 — rents don’t follow prices.
Prices follow rents. And the only reason
rents will rise is when tenant demand
exceeds the supply of space, and we don’t
see that today. The good news for San
Diego is that The Irvine Company is a long-term owner. They didn’t buy these irreplaceable assets for what they can generate in income in the next two to three
years. Unlike the institutional speculators,
Irvine will take a long-term view, put capital into these buildings to fix deferred
maintenance and improve the quality of
their assets. Irvine understands the market
for tenants, and yes, they are going to try
and push rents. It’s our job to push back,
and to use our collective bargaining on
behalf of tenants of all sizes to make sure
that rents don’t move unless and until the
market supports it.
Let’s not forget that in San Diego there is
currently 4.65 million square feet of sub-lease space, and that number is steadily
increasing. People are surprised to learn
that the average time on the market for
available space is a shocking 15 months!
These are important market facts, and they
don’t point to rising rents. Like we’ve said
all along, the only things that will eventually drive up rental rates are robust job
growth, positive net absorption and the
good old rule of supply and demand.
JOHN JARVIS is a principal and senior vice president with
Irving Hughes. Reach him at [email protected].