The Orange County office market is likely to see significant changes in 2007,
which may strengthen the position of tenants and counteract the longstanding
advantage held by landlords. Although
vacancy rates remain at historically low levels, office development in Orange County is
greater than any other region in the state
and may provide a platform that enables
tenants to capitalize on the changing market
conditions.
“In order to thoroughly understand the
effects of the changing real estate market
and how it relates to their current lease situation, companies need to consult real estate
professionals,” says Clint Hubbard, a senior
advisor with CRESA Partners Orange
County. “These professionals can complete
accurate extrapolations of how different
factors, such as a tax basis increase, can
affect occupancy costs for specific tenants.”
Smart Business spoke with Hubbard
about current changes in the Orange County
real estate office market and how these
developments could have an impact on tenants.
How do frequent changes in ownership affect
commercial property tenants?
The strong valuation of commercial real
estate in Orange County has led to an influx
of investor money and substantial capital
gains for those disposing of real estate
assets. Upon a sale, property value is
reassessed and unless tenants have negotiated tax protection within their lease, they
are responsible for the extra expense on a
pro rata basis.
One of Orange County’s largest portfolio
sales recently occurred: Equity Office
Properties Trust, formerly the largest holder
of office real estate in the country, sold to
Blackstone Group LLP. Blackstone then
strategically sold a portion of the portfolio,
including its holdings in Orange County to
Maguire Properties, Inc. As a result, large
amounts of local office space have gone
through two ownership changes and two
increases in property value, which will significantly increase property tax bills for current tenants. Additionally, Maguire Properties plans to increase rent on the spaces by 20 to 26 percent within the next three
years.
How does ownership consolidation change
the office market?
Ownership consolidation puts fewer players in control, which can have both positive
and negative effects on tenants. On the positive side, the introduction of multiple
strong players into a market previously
dominated by a single major player increases the level of competition. On the negative
side, consolidation means holders of large
portfolios can act more bullish on markets
and better control rental increases.
Landlords with extensive real estate holdings can up the rent on all of their properties, effectively decreasing the supply of
similar space offered at lower rates.
The largest landlord in Orange County
owns approximately 25 million of the 79
million square feet of office space in the
county. Maguire’s acquisition of approximately 6.1 million square feet in the deal
mentioned above, clearly establishes its
position as the second-largest landlord in
Orange County with 10.3 million square feet
of office space. Maguire’s plans to significantly increase rates on office space, considered below market value, will force some high-rise tenants to look into alternative spaces.
How will new high-rise development have an
impact on the office market?
The new blocks of space will offer long-needed alternatives for mid- to large-size
users. Approximately 4 million square feet
of office space is under construction with
plans to deliver building shells in middle to
late 2007, of which only 40 percent has been
pre-leased. Landlords are now having to
compete for tenants and courting them
aggressively.
Landlord improvement packages are more
significant with the new office space offered
in shell condition. These packages subsidize
the cost of the build-out and the construction costs. However, larger improvement
packages often translate into increased
rental rates as developers offer more capital
upfront but look to amortize a portion of the
expenses over the duration of the term.
How can skilled real estate consultants help
tenants leverage the changes?
First and foremost, engaging a professional real estate adviser alerts landlords that
you understand how your current space
competes with alternative properties in the
market. A knowledgeable tenant representative also understands how to create maximum leverage through competition, therein
generating greater landlord concessions in
terms of both lease economics and lease
terms.
Your adviser should also have the analytical skills to accurately compare and quantify the best and worst-case lease structures
both from a short- and long-term economic
perspective. The best tenant advisers will
negotiate protection clauses within the
lease, identify and mitigate liability concerns and effectively lead the entire real
estate process to ensure the best interests of
the client is served from the beginning of the
project to its completion.
CLINT HUBBARD is a senior advisor with CRESA Partners Orange County. Reach him at [email protected]
or (949) 706-6589.