Lower Rents, Relocations Attract Investors, Users to Inland Empire’s Office Market

by Taylor Williams

The Inland Empire office market got off to a slow start in 2018, continuing a trend of positive momentum with little excitement. The average asking rent registered $1.81 per square foot, down 3.7 percent from the fourth quarter of 2017 and $0.01 below the first quarter of 2017.

Preliminary sales and lease volumes are off 39.1 percent over the prior year. However, the Inland Empire is seeing one of the lowest vacancy rates since 2007, with more than 108,000 square feet of new construction added to the market this quarter. As of the first quarter of 2018, vacancy was 7.9 percent, down 30 basis points over the quarter and 90 basis points below last year at this time.

Nine projects totaling 201,671 square feet are under construction, with the largest being Rady Children’s Medical Plaza at 60,000 square feet. Much of the new growth in the office sector is being driven by the healthcare industry.

Office medical space comprised more than half of the space under construction, as the education and health services sector employment has grown by 4 percent between January 2017 and January 2018. This has accounted for 8,800 of the 13,500 new jobs in the office-occupying sectors. Over the same time, total employment grew by 52,600 jobs, while the unemployment rate dropped from 5.8 percent to 4.5 percent.

Trends to Watch

Despite the slow start to the year, the Inland Empire office market is moving in a positive direction in 2018. The Inland Empire could experience additional growth coming from Orange County tenants escaping tight market conditions and significantly higher rents. Due to brisk demand, landlords are also holding back on the generous concessions once needed to entice tenants.

The education and health services sectors should continue to be major drivers for office space in 2018. Developers have responded to the market as office medical space comprises a significant portion of new construction.

Virtually all projects in the Inland Empire’s construction pipeline are scheduled for delivery in the first half of the year, with 63.7 percent of the space preleased or expected to be occupied upon delivery. Several major projects are slated to begin construction this year, including the 240,966-square-foot Creekside Corporate Center in Murrieta and the 149,621-square-foot Lake Shore Plaza Office Center in Corona.

As of mid-March 2017, leasing activity slowed significantly in the first quarter, totaling just 395,667 square feet. Leasing volume is 59.7 percent lower compared to the prior quarter and 46.2 percent below last year at this time. The average asking rental rate also dipped in the first quarter to $1.81 per square foot, down $0.07 per square foot from the fourth quarter of 2017 and down $0.01 per square foot from the first quarter of 2017.

Lower asking rents in the Inland Empire compared to neighboring Orange County and Los Angeles County are attractive to tenants – as those office markets price tenants out of the market with significantly higher asking rents. While rents have been slow to respond to tightening market conditions, the vacancy rate is at the lowest level since 2007.

Similar to the leasing volume in the Inland Empire office market, sale volume is down in the first quarter of 2018. The latest figures available showed there were 59 sale transactions, half of the previous quarter’s amount, and fewer than the 110 seen last year. Transaction volume totaled 764,098 square feet, which represented a decline of 43.7 percent over the prior quarter and a 34.4 percent drop from last year.

The average sale price was $166 per square foot, up 3.7 percent over the quarter and down 1.2 percent over the year. Cap rates averaged 7.58 percent, down 25 basis points over the prior quarter and up 101 basis points from the first quarter of 2017. Sales are expected to remain elevated, with demand coming from investors and owner users.

— By John D. Boyer, executive managing director, NAI Capital (Ontario, Calif.) This article first appeared in the April 2018 issue of Western Real Estate Business magazine. 

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