SOCAL Commercial Real Estate Market Going Backwards

Inland Southern California is running out of industrial space, especially for the users of high-profile, big-box distribution centers. But while developers are purchasing and building new warehouses in Riverside and San Bernardino counties, the head count in its office buildings is getting even lighter. The vacancy rate for the office market is expected to end 2011 at 25 percent, one commercial real estate operator predicted late last month.

That means that, in two years, one of the unhealthiest facets of the Inland economy has gotten worse, not better. However, there are a few subsets of this sector that would take exception to the definition of “worse.” One would be investors, who have been able to buy distressed properties for far less than the cost of a new building.

Another is the existing office tenant. Many are locking up very favorable long-term lease rates. Marcus & Millichap is predicting a 25 percent vacancy rate at the end of the year, one of the highest in the nation. If the forecast holds true, it will mean a slight worsening of the 24.8 percent at the end of 2010. Some 2- or 3-year-old buildings are still mostly empty or unoccupied.

Professionals in the industry say they have to look no further than the latest statistics from the state on job growth to explain why one in every four square feet of Inland office space is empty. Right now, few employers are in position to put new people at Inland desks. “Whether it’s government or education or consulting, it’s just not getting better,” said Mary Sullivan, a commercial real estate consultant. “The office market is tied more to employment than the other commercial markets.”

The latest report on job growth for Inland Southern California shows a decline of more than 12,000 government jobs in the last year. More than two thirds of those lost jobs are in education, but many are desk jobs. There have also been year-over-year job losses in professional and technical offices, and the financial sector, an area that saw companies fight each other for the best office space five years ago, is barely growing now.

Vacancies are highest in Ontario and Rancho Cucamonga, the cities considered the Inland Empire’s economic center. In the last 12 months, the vacancy rate increased faster in the Temecula and Murrieta area.
Eastern San Bernardino County, including San Bernardino and Redlands, will likely be the only submarket to see its vacancy rate drop in 2011, and only by about half of one percent, Marcus & Millichap is predicting.

The office market’s struggles mirror the Inland area’s residential housing situation in many ways. There was a construction fervor that started in 2005 and 2006, but by the time many office buildings were completed the area was in the grips of a recession and few firms wanted to expand.
But while there are few new buyers coming to the area, it does not mean the commercial real estate industry is fallow. Burback said many tenants already in the Inland area are either trying to renegotiate their leases or are willing to look for cheaper space that offers similar amenities.

That means there’s lots of activity, none of which drives the vacancy rate down. Burback said that, for tenants, deals like those make sense. “If my lease were up I would renegotiate or move to a comparable Class A space, probably at a 15 to 20 percent lower rate,” Burback said. “I know I could do that.”

There are no plans for new larger buildings. “We have to burn off that excess inventory and have a reason to build new buildings,” John said. “But that won’t be here for a while.”

Investors could be another beneficiary of a depressed market. About three months ago, Newport Beach-based TA Realty Advisors purchased the four-story Empire Corporate Center, a Class A tower in Ontario, for $9.25 million. The $113-per-square-foot price tag was significantly less than the replacement value, which was probably about $150 per square foot.

Also, in the last two months, smaller buildings in Corona and Murrieta were sold by lenders. Neither had anywhere close to a full roster of tenants, but the upside was the price. The depressed market is an opportunity for doctors who, in search of a nest egg, might want to buy a property that will provide retirement income.

Neither of those trends will dent the 25 percent vacancy rate. But Sullivan predicted that, when companies are ready to expand, the region’s Class A buildings will be noticed.