The Orange County industrial market has been facing ups and downs during the second quarter. Vacancy rates have been rising, and net absorption remains negative. Despite these challenges, there are some positive aspects, such as an increase in gross absorption and rising average lease rates. Let's delve deeper into the factors affecting the market and explore the potential opportunities it holds.
A Rise in Vacancy and Availability
In the second quarter, the vacancy rate in Orange County increased by 56 basis points, reaching 2.02%. Additionally, the availability rate, which includes occupied spaces listed for lease or sale, rose by 83 basis points to 3.94%. The increase in sublease space has provided tenants with more options, resulting in longer time on the market. Landlords are adjusting their strategies, offering free rent and tenant improvements to attract long-term, creditworthy tenants. However, the scarcity of available space for sale has helped control the rise in vacancy rates.
Lease Rates and Sales Prices Surprisingly Climb
Despite the rising vacancy rates, the average asking lease rate in the county continues to increase. It moved up by $0.06 per square foot in Q2, reaching $1.68. Year over year, asking rents have grown by 25%, defying the market conditions. Similarly, the average asking sales price surged to a record high of $424.37 per square foot in Q2. However, this jump is influenced by more small-sized buildings being offered for sale at higher prices. The demand from owner/users has slightly decreased due to higher mortgage rates, but limited supply has allowed sellers to maintain firm pricing.
Transaction Activity Shows Moderation
Transaction activity in the industrial market experienced little change in Q2. High-quality, functional spaces are scarce, and older spaces with functional obsolescence dominate the market. The decrease in active requirements has resulted in reduced competition for available spaces, lessening the urgency for tenants and buyers to make quick decisions. Although lease transactions increased to 209 from 189 in Q1, the number of sales dropped from 41 to 25 during the same period. Total lease and sale activity by square footage also declined from 2.9 MSF to 2.6 MSF in Q2. Furthermore, the time on the market for spaces is increasing, reflecting a more cautious approach from both buyers and tenants.
Absorption Challenges Persist
For the second consecutive quarter, Orange County experienced negative net absorption. In Q2, the overall loss in occupied space was 194,101 SF. Cypress and Anaheim recorded the biggest drops in occupied space, while Fullerton showed positive net absorption of 229,655 SF. Gross absorption, which measures total move-ins, increased to 2,740,680 SF in Q2. Despite these challenges, some submarkets, like North County, showed positive net absorption.
Construction and Employment Trends
Construction in the county fell slightly in Q2, with a current pipeline of 16 buildings in eleven cities. Class A distribution facilities, in high demand from e-commerce users, constitute 12 of these buildings. The largest project, Goodman Commerce Center Cypress, is expected to complete in Q3 2024.
As for employment, the unemployment rate in Orange County was 3.2% in May 2023, slightly up from April 2023. Several sectors, including private education and health services, trade, transportation, and utilities, contributed to an increase in jobs.
Forecast
Vacancy rates in the for-lease industrial market are expected to increase gradually due to uncertain economic conditions, leading to softer demand for space. As a result, there will be downward pricing pressure on less functional buildings offered for lease. However, higher-quality spaces will still command premium lease rates. With longer time-on-market for spaces, tenants will have more negotiating power.
Despite a doubling of mortgage interest rates in the past 18 months, the sale market has shown remarkable resilience. The inventory of for-sale industrial properties is expected to remain tight, as long-term property owners are hesitant to sell due to potential capital gains taxes. Construction activity is projected to decrease over the next year, as projects are delayed due to higher capital costs and economic uncertainty, limiting rent growth prospects. Institutional investors are shifting their focus from value-add acquisitions to stabilized assets with strong credit tenants.
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