Orange County is currently undergoing a significant transformation, characterized by a seismic shift between its thriving industrial sector and a struggling office market. This transition is prominently observed in the region’s most concentrated cluster of office-to-industrial conversions.
During the first quarter of 2023, a noteworthy 17 properties, encompassing a total of 3.2 million square feet of office space, were earmarked for conversion into industrial facilities within Orange County. This trend aligns with the robust industrial market prevailing in Southern California, boasting an impressive industrial footprint exceeding 2.3 billion square feet.
One such example exemplifying this shift is the demolition of Elevate @ Harbor in Santa Ana, a site comprising two office properties. This strategic demolition paves the way for the development of proposed industrial facilities, effectively addressing the burgeoning demand for industrial space in the area.
In a calculated move, Kearny Real Estate, in collaboration with Dune Real Estate Partners, has made the decision to demolish a recently renovated office campus in Orange County. The renovation, which incurred costs of $15 million, will be superseded by the construction of a warehouse spanning an impressive 163,000 square feet. Situated at 3130 South Harbor Boulevard, this project involves replacing two office buildings with a modern industrial facility. Kearny initially acquired the office campus for approximately $35 million in 2018, augmenting their investment through the renovations aimed at attracting a millennial workforce.
Aligned with numerous real estate firms in the post-pandemic era, Kearny is strategically pivoting its focus away from the office sector in Southern California, capitalizing on the thriving industrial market. The expanding industrial footprint in Southern California, coupled with the ongoing weakness experienced in the Orange County office sector, has propelled Kearny to conclude that industrial utilization offers the most promising long-term prospects for the property.
The Orange County office market has encountered notable challenges, as substantiated by the findings in a Q1 2023 market report. The report reveals negative net absorption of 1.1 million square feet, with vacancy rates reaching nearly 18%. Additionally, sublease vacancies surpassed 2.3 million square feet, indicative of a considerable surplus of available office space. Perhaps most telling of all, no new construction initiatives were undertaken within the county, reflecting the prevailing skepticism surrounding the future prospects of the office market.
Throughout the first quarter, leasing volume in Orange County experienced a decline as companies tightened their budgets amidst economic uncertainties. Consequently, the office leasing market displayed a subdued performance, with a 10% decrease in leasing activity compared to the previous quarter, accompanied by a significant 38% reduction in average leasing sizes for Q1 2023.
Furthermore, sublease availability in Orange County reached an unprecedented high of 3.9 million square feet in Q1, reflecting a notable 3.6% increase from the previous quarter. The surge in sublease space was primarily attributed to tech tenants reassessing their office space requirements.
In response to these challenges, a flight-to-quality trend was observed, resulting in a 1.8% growth in the average asking rent in Orange County, relative to the previous quarter. Premium buildings commanded higher rental rates in the market, as landlords, grappling with elevated vacancy levels, proffered attractive concessions to entice tenants. Consequently, tenants could secure more favorable leasing terms despite the higher face rents.
As Orange County navigates this transformative phase, defined by the surge in its industrial sector and the challenges faced by its office market, the escalating demand for industrial space remains evident. This paradigm shift underscores the imperative for real estate investors and developers to adapt to the evolving landscape and seize opportunities within the thriving industrial market.
