04 August 2011


Story first appeared in Bloomberg News.

Investors are bidding up prices for top-tier office buildings in Orange County, California, even as vacancies stand at almost 20 percent after the collapse of the subprime-mortgage industry that once made the region its home.

Prices paid for offices in the area climbed 63 percent to $111 a square foot in the second quarter from recession lows of $68 in 2009. An 11-story building near John Wayne Airport is on the market at $225 a square foot, up 80 percent from the $125 it fetched two years ago.

The gains come in a region where vacancies more than doubled with the
2007 collapse of subprime lenders including New Century Financial Corp. and Ameriquest Mortgage Co., both of which were based in Orange County. Second-quarter asking rents were down 31 percent from the 2007 peak, and office vacancies stood at 19.2 percent. That compares with a 17.2 percent rate nationwide.

Capitalization rates, a measure of investment yield, for Orange County office buildings dropped to an average of 6.9 percent in the second quarter from 7.7 percent in all of last year and 7.9 percent in 2009.‘Premium Price’

Orange County, home to the Disneyland and Knott’s Berry Farm amusement parks, has been attractive to office buyers because of the region’s excellent infrastructure, school system and weather.

The region was a major U.S. hub for mortgage lending. The financial-market crisis had a major impact on these firms and employment. It spelled the end of Orange County.

Joblessness in the county soared to a high of 10 percent in January 2010 from 3.1 percent in December 2006, during the property boom, according to California’s Employment Development Department. In May, the latest month for which figures are available, the rate was 8.5 percent. Office vacancies rose to a high of 21.8 percent in the second quarter of last year from a low of 8.6 percent in mid-2006, Cushman said.

Office transactions of more than $5 million climbed 55 percent to $1.09 billion last year from $701.8 million in 2009. That compares with about $6.33 billion in the 2007 peak.
Volume so far in 2011 totals $260.6 million.

Emmes Group of Cos., based in New York, in June 2009 paid $160 million, or $302 per square foot, for the 20-story 3161 Michelson Ave. in Irvine, which was 38 percent vacant at the time. The price included a parking garage.

The building was developed as the headquarters for New Century, the largest independent mortgage lender to subprime borrowers before it collapsed in 2007 as defaults by homeowners with poor credit soared. The company never occupied the space.

The property used to belong to MPG Office Trust Inc., the Los Angeles- based landlord formerly known as Maguire Properties. MPG has been disposing of buildings to reduce debt after paying $2.88 billion for all the real estate in downtown Los Angeles and Orange County that Blackstone Group LP purchased in its acquisition of Sam Zell’s Equity Office Properties Trust.

Vacancies at 3161 Michelson have dropped to about 24 percent. Tenants include Hyundai Capital, Jacobs Engineering Group Inc. and real estate services provider Eastdil Secured LLC.

Irvine Co. said in December that it bought Pacific Arts Plaza in Costa Mesa, an 827,000-square-foot (77,000-square meter) property with four office buildings and four restaurants, for an undisclosed amount.

They commented that because they think they will see positive returns in the future, they are comfortable with prices that have more modest initial yields on investments as they believe the recovery will outperform what most people anticipate.

Ocean West Capital Partners, founded early last year, completed the purchase of a 16-story building at 2600 Michelson for about $70 million, or $228 a square foot, this month. The property, previously owned by MPG and 50 percent vacant, had been under receivership for a year and a half.

Ocean West bought the building in a joint venture with New York-based Dune Real Estate Partners.

Their view is they get to step in to reposition the building and to reintroduce it to the market. They expected horizon for returns is around five years. They are already seeing some leasing activity since they acquired the building.

While occupancies are starting to rise in Orange County, rents remain depressed. The average monthly asking rent at Class A, or the highest - quality, office buildings was $2.15 a square foot in the second quarter, down 5.7 percent from a year earlier. That compares with a record $3.13 in the third quarter of 2007.

Epicor Software Corp. in February signed a 10-year lease for about 68,000 square feet at a Class A building near John Wayne Airport -- a centrally located area with a high concentration of top-tier properties -- for $1.72 a square foot, which includes such services as heat and water. In May, Access Insurance Holdings Inc. agreed to a five-year lease for 31,000 square feet at a Class A building in Orange at the same rate, the brokerage said.

Those actively buying, mostly local investors who understand the market, are counting on a recovery in a region where new construction was nonexistent in the first quarter. While Orange County will come back, some office buyers may have to wait 10 years for returns.

A broader recovery in Orange County is dependent upon a decline in unemployment, which would help boost office demand and rents.

What’s striking is how quickly the appetite has returned to such a ferocious level after such a low point. In 2005, 2006 and 2007, it moved so quickly. In the last 12 months, it’s moved as quickly in terms of expectations.

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