Orange County’s Retail Vacancy is Tight, but Capital Markets Activity Will Be Sluggish this Year

by Jeff Shaw

— By Terrison Quinn, Managing Principal, SRS Real Estate Partners —

The Orange County retail property market was very active last year for both leasing and capital markets. At 4 percent, Orange County’s retail vacancy was back down to pre-pandemic levels. There was an annual net positive absorption of 445,000 square feet with 191,000 square feet of new space delivered in 2022, per CoStar.

Average rents increased 5 percent from an average market rent of $34.84 per square foot, per year to $36.58 — the highest rate of rent growth in 10 years. We don’t see rents coming down at all this year, especially as there’s only 170,000 square feet of new space currently under construction and we continue to experience favorable consumer demand.  

From a capital markets perspective, investment activity remains to be seen. In line with national trends, many investors and lenders are putting capital deployment on pause as they analyze economic activity and adjust to a period of higher interest rates, higher inflation and, perhaps surprisingly, strong employment. Despite the angst that comes from uncertainty, there is a lot of positive sentiment toward economic corrections, creating investment opportunities over the coming years. This is certainly the case in a coastal Southern California market like Orange County that benefits from a diverse economy with high incomes, strong employment and elevated barriers to entry.  

There are some interesting metrics that demonstrate consumer demand. U.S. retail sales on Black Friday were up 12 percent year over year, according to Mastercard SpendingPulse data. The National Retail Federation also indicated a 17 percent year-over-year increase in foot traffic on Black Friday, which was considerably higher than expected. This is happening at the same time online sales from Black Friday and Cyber Monday are hitting records. This could be indicative of maturity forming between omnichannel retailers and their customers.

On the flip side, strong consumer demand is happening at a time when consumer saving figures are shrinking, and debt levels are the highest they have ever been. According to the New York Fed, total household debt increased $351 billion in the third quarter of 2022, the highest nominal increase since 2007. This would imply that aggressive consumer spending will tighten at some point. However, this may not be until late 2023 or even 2024, especially since personal savings rates jumped considerably due to the pandemic. 

While aggressive consumer spending props up leasing activity, the capital markets are already in correction territory. Quarter-one 2023 data is expected to show a decrease in overall deal volume and a mild increase in cap rate. There were some large transactions in Orange County in early 2022, including Brixmor’s $85.7 million purchase of Brea Gateway and World Premier Investments’ $102.5 million purchase of Fullerton Town Center. Other than those, there have been no significant recent transactions in Orange County.  

As the cost of debt has increased in a low cap rate environment of an overall 5 percent, transactions have fallen to the lowest amount since early 2021, Costar notes. This year is expected to realize lower sales volume than last year as lenders and borrowers adjust to changes in interest rates. Opportunistic investors with considerable cash reserves and a willingness to take on some risk will be in an excellent position to capitalize on assets. That’s because Orange County retail is an excellent investment and historically more resilient than many other major markets across the country.

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