Office space Featured

8:00pm EDT March 26, 2007
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 chubbard@cresapartners.com or (949) 706-6589.