Orange County

Southern California's six major counties, excluding San Diego, gained more than 5 million residents between 1980 and 2000. Even more remarkable, they are expected to do the same during the next two decades. Although such torrid growth puts immense strain on the region's available housing, it creates tremendous opportunity for investors and developers.

Orange County faces an especially acute housing crunch. Much of its available land has long since been built out, and new single-family homes are not becoming available fast enough to satisfy demand. The classic market imbalance is sending home prices skyrocketing far above those in surrounding areas. An average single-family house in Orange County fetches $392,000?more than double the national median and double the average for homes in nearby Riverside County. It is no wonder that many people who work in Orange County are forced to live elsewhere.

"The commutes between Orange and Riverside counties are legendary in terms of their being so difficult," said Joseph Carreras, lead regional planner for the Southern California Association of Governments, a regional planning agency. "The labor force finds itself on the road a lot in order to commute to work or drive to the things that are important for daily living."

But will killer commutes and soaring home prices led to a greater demand for multi-family units in Orange County? The answer depends on who you ask.

Dale Kemp, CFO of MBK Real Estate Ltd., believes that despite rising prices, buyers are still able to take the plunge into homeownership, thanks to low interest rates. "What we're seeing right now is anybody who can possibly afford to buy is buying, so it's hurting the rental markets at the moment."

Another observer sees things differently. "Approximately 50 percent of (multi-family dwellers) in Orange County live in apartments by choice; the other 50 percent can't afford to live in a house," said David DePillo, vice chairman, president & COO of Commercial Capital Bancorp Inc. This ratio is starting to skew in the direction of renting by necessity, he added. "With the tremendous velocity in the residential market, affordability is getting further out of reach."

The statistics are also split. In spite of rising unemployment, which helped add 170 basis points to Orange County's already low 2.3 percent multi-family vacancy rate, rents actually rose during 2001 and into the first quarter of this year, according to Reis Inc.

Spurred by these rent increases, investors are optimistic about the multi-family sector. "It's becoming very much a seller's market again. We're seeing a lot of multiple offers, and the back-up offers are significantly higher than what was accepted. Owners that had purchased property in the last two years have seen substantial appreciation," DePillo said.

The data appears to support his observation. For garden-style apartments, the most common type of multi-family product in Orange County, the price-per-unit-sold averaged $107,000 for the period between first quarter 2001 and first quarter 2002?well above the $82,000 average for garden-style units in other western states and nearly double the $59,000 national average, according to Real Capital Analytics. Cap rates for garden-style product, meanwhile, were lower in Orange County during the same time period: 7.8 percent vs. 8.2 percent in the West and 8.7 percent nationwide.

Developers are therefore taking notice of Orange County's investor appeal. They will deliver 4,384 units this year, compared with roughly half that number in 2001, according to Reis.

But not everyone believes that Orange County boasts a market of renters-by-choice that is eager to lease these new digs. All things being equal, most people would rather own a home than rent, according to Rob Parker, vice president of Sares-Regis Group. "What we've found in our research is that ... it's not the income that drives demand (for apartments), it is the ability to fund a down payment that drives demand for apartments," he explained. And although the cost of a down payment is rising, the amount is not yet out of reach for those in a position to buy.



Mixed Use, Mixed Message

To cultivate a larger renter-by-choice market, and to make apartment living more palatable for those who cannot afford a down payment, developers must supply a product that is more unique, Parker continued. In Orange County?a region which generally lives up to its stereotype of gated suburbs, mega-malls and sprawling office campuses accessible only by car?mixed-use development could be just the ticket.

"Developers still see Orange County as a bedroom community and suburban market, but it's not anymore. There are (2.8 million) people here now, and people have moved here from places like New York, Chicago and San Francisco. They are used to a more dense environment and they can't find it. The first developer that comes along and builds a mixed-use, high-density, pedestrian-friendly rental community will be very successful," Parker said.

Although none of Sares-Regis Group's current developments are truly mixed-use?zoning in many of Orange County's municipalities still prohibit housing, retail and office uses within a single property?its Watermarke apartment complex in Irvine is based on the same pedestrian-friendly principles that guide many mixed-use projects. Currently under construction, the 548 multi-family units resemble brownstone townhouses.

"It's very much open to the street, and we're not surrounding this thing with a solid wall," Parker said. "It's in direct contrast to another development that's one block away ? that's going to be more than 1,000 units and all fenced in."

Mixed use projects, redevelopment and in-fill development are becoming increasingly necessary in Orange County, observed Carreras. The trend toward this type of development is largely attributable to the county's shrinking greenfields, but it also stems from a desire to remain economically competitive. "Housing is beginning to be more than just a place where jobs sleep. It's also a tool to use in improving your economic competitiveness as a community."

It is not just Sares-Regis, therefore, that is looking at mixed-use development in Orange County. "From a development perspective, (combining retail and multi-family) makes a lot of sense because you've got cross-pollination between the two product types. You've got a built-in shopping base," said Jeffrey Leon, director of acquisitions for Rawson, Blum & Leon.

In conjunction with its joint venture partner, Buchanan Urban Investors, Leon's company recently purchased the 822,000-square-foot Mall of Orange. Although the mall is 89 percent leased, the 30-year-old center is showing its age and thus traded at a discounted rate of $24.2 million.

"It was an exceptionally well-located, enclosed regional mall that, for just a variety of reasons, had lacked capital infusion over the past number of years," observed Larry Krasner, senior managing director of Insignia/ESG Capital Advisors Group and broker of the sale. "(The new owners) will bring what was a tired mall into the 21st century."

In addition to a cosmetic makeover and lease restructuring, Rawson, Blum & Leon is also evaluating whether to add a multi-family component elsewhere on the site. "We bought this property as a repositioning opportunity solely focused on the retail aspect. The housing component is something we're looking at, but it is not a driving factor," Leon said.

Although the Mall of Orange represents an excellent chance for Rawson, Blum & Leon to undertake a retail repositioning, both Leon and Krasner agree that these opportunities are few and far between in Orange County. Most of the county's older centers, found mainly in the Anaheim and Brea areas to the north, have already been renovated or repositioned.

Nevertheless, MBK is hoping that some opportunities remain. In addition to its home-building arm, MBK also operates a retail division that specializes in converting enclosed shopping malls into open-air power centers. Ironically, although MBK is based in Orange County, all of its retail properties are located elsewhere. This could soon change.

"We're seeking to acquire $80 million of retail properties in the Los Angeles and/or Orange County markets," Kemp said. "We don't look at it so much as there being more distressed properties now. ... We see it more as we're just expanding our growth, and it makes sense to do that in our own backyard." Industrial Hot, Office Not

As temperatures in Orange County have risen this summer, sale prices for industrial properties have kept pace. "The hot spot in our market today is the industrial investment market. It's the hottest thing out there. I don't think I've ever seen it so hot," said Rob Socci, senior vice president of Voit Commercial Brokerage.

Interestingly, not all industrial properties are equally hot. Thanks to the recession, fewer tenants are leasing large industrial buildings; therefore, fewer of these properties are selling. "It used to be that size was an advantage. Two or three years ago, big buildings were easier to sell or lease. Now it's just the opposite. If you're big, you're sitting," Socci said.

Buildings that are trading now average less than 40,000 square feet. Buyers, meanwhile, are the would-be occupants of these spaces. Chuck Hunt, senior managing director of Cushman & Wakefield Inc., credits this trend to low interest rates and an effective loan program offered by the U.S. Small Business Administration. "It would cost (businesses) more money to lease than it would to own," he explained.

Investor appetite for big buildings could be warming again, however. In one of June's more notable deals, brokered by Socci, LBA Industrial Fund L.L.C. purchased the Canyon Commerce Center from CB Richard Ellis Investors L.L.C. for $15.7 million. Located in Anaheim, the complex of warehouses and light manufacturing facilities totals 215,000 square feet and is 95 percent leased to a variety of tenants. As such, it is typical of the bigger industrial properties that institutional investors find attractive.

"I do think (larger buildings) are going to start trading again. I think the second half of this year should be more active," said Phil Belling, a principal of Layton-Belling & Associates, which manages the investment fund that purchased the Canyon Commerce buildings.

Real estate players in Orange County's office markets, meanwhile, are not as sanguine. "We have more vacancy here now than we have had in a lot of years," said Michael Kendall, vice president & regional partner of Koll Development Co. "The good news is, there's not a lot of new product coming online that will contribute to any new vacancy. What could contribute to vacancy is if any companies downsize ... but I don't think we're going to see another round of layoffs."

Fortunately, Koll has had luck finding tenants for its 1901 Main St. office development, a recently completed companion to its 1900 Main St. building near the John Wayne Airport. As of June, the 178,000-square-foot building stood 55 percent leased. "Activity has certainly been slower than it was on the first building, but one pleasant surprise is that the credit of the tenants has been strong," Kendall said.

Tenants certainly have their pick of spaces from which to choose. The countywide vacancy rate topped 15 percent on a direct basis, nearly 18 percent overall, during first quarter 2002, according to Cushman & Wakefield Inc. Hardest hit was the South County submarket, where the direct and overall vacancy rates average approximately 27 percent.

"If there was a tenant in the market today, that tenant is enjoying his shopping expedition," observed Kevin Hayes, president of The Staubach Co.'s western region. "Most of the market is musical chairs right now of existing tenants. The positive absorption that Orange County has enjoyed for virtually a decade has, over the past year, slowed to near zero."

As a result, concessions of all types have crept into the market: Landlords are offering both reduced rental rates as well as beefed-up tenant improvement allowances. The Irvine Co., for example, dropped its rental rates by one-third to attract BAX Global Inc., which leased 116,210 square feet in its Irvine Technology Center. "That transaction was considerably more aggressive than the rental rates would have been a year earlier," observed Hayes, who brokered the deal on BAX's behalf in April.

Although very few leases for more than 100,000 square feet have been signed since last year, smaller tenants such as insurance offices, accountants and financial service firms are taking down small chunks of space with gusto. "I'm doing leases from 2,000 to 3,000 square feet all day long," said William Hugron, managing director of Charles Dunn Co.