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1/2112020 Volt's Q4 2019 OC Office Market Report & 2020 Forecast —Just Released • Orange County Office Space I Commercial Real Estate I To... v®itworks (https://voitworks.com/) Volt's Q4 2019 OC Office Market Report & 2020 Forecast - Just Released! It, STE FAN New Decade. Same Cycle. 2019 was another good year for the OC office market. A diversified, well-educated employment base continues to keep the office market on firm footing. Consistent demand has kept lease rates and sale prices on an upward trend notwithstanding the significant spike in speculative office development over the past two years. This year technology tenants are expected to dominate leasing, which Isn't surprising because they accounted for 22% of the activity through the first half of 2019. Interest in flexible office space will continue to grow, but at a much slower pace thanks to the recently botched WeWork IPO. Political activity continues to impact the overall CRE outlook. The House has passed the USMCA (NAFPA 2.0) and it is expected to be signed into law in January. Many believe the new law will strengthen U.S. trade with Canada and Mexico. Tax incentives for energy -efficient commercial buildings have been extended, allowing owners to claim a deduction of up to $1.80 /SF for qualifying systems. Of great concern going forward is the California Schools and Local Communities Funding Act, which will likely be on the ballot in November. This controversial initiative would remove Prop 13 protection for most commercial properties. Beginning with the 2021-22 tax year, commercial property would be subject to periodic reassessment to full market value even if it does not change hands. Tenants subject to operating expense pass -through could be forced to absorb huge tax Increases, while investors who cannot pass those increases along would see a decline in property values due to lower NOL Looking ahead, I'm keeping an eye on these key market drivers: #I: Interest rates will remain low. The Fed's three rate cuts in 2019 made clear its intentions to avoid recession. We expect interest rates to remain stable going forward, which makes 2020 a good year to acquire or refinance office properties. #2: The creative and progressive design trends that have dominated the OC office market since 2015 will continue. The latest iteration is the'butdood' office and developers have taken note. Employees, predominantly millennials and Gen Z, expect an excellent experience at work, which means spaces with high levels of choice, variety and balance. #3: The alternative investment sector of CRE will remain strong. Data center, self -storage and medical office activity has doubled since 2008, making up approximately 12% of all CRF, activity. As this trend continues, expect to see adaptive reuse projects growing in popularity. Old factories, mills, schools, vacant retail boxes and more are being converted into flex space and residential housing. Programs like Opportunity Zones or the Low-income Housing Tax Credit will further support those efforts, Barring a catastrophic economic disturbance, 2020 should be another solid year for Orange County's economy and commercial real estate market. OC Office Market Overview The OC office market has stabilized into a relatively strong and stable position. Vacancy remains manageable, but has ticked up slightly in the past year. Technology, Financial Services, and Health Services firms have driven a significant amount of recent leasing activity, However, expanding companies are leveraging new workplace technologies to save money by increasing the number of employees for each square foot of space they lease, and that has had an impact on overall absorption and transaction velocity. Tenants in Class A and B buildings who leased space early in the recovery cycle are getting sticker shock at renewal time, as rent growth, which has moderated in recent quarters, is up substantially over the past 5 years. To mitigate higher per square foot occupancy costs, many tenants are moving down in building class and taking less space by switching to more open workspace designs. The market has seen modest levels of supply additions in recent years compared with previous development cycles, but several of the Class A projects delivered over the past two years are leasing up more slowly than expected. Net absorption, though still in positive territory, has been softening over the past several years. Capital market conditions remain solid, and while sales volume is down from its record level back in 2016 and 2017, it remains robust. Cap rates remain at or near historical lows, especially for high quality Class A and B assets. Vacancy Rates Nearly 1.39M SF of space has been delivered in the OC office market since Q12019, expanding the office base by 1.2%. This has contributed to the uptick in overall vacancy. Direct / sublease space (unoccupied) finished the quarter at 11,44%, up 48 basis point year -over -year. North Orange County posted the lowest vacancy rate at 7.17%, while the Airport Area and Central County had vacancy rates greater than 12% at the end of fourth quarter. Higher vacancy in the Airport Area is mainly https://voitworks.com/2020/01/commercial-real-estate-news/voits-q4-2019-oc-offce-market-report-2020-forecast-just-released/ 1/4