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Office Fallout in Orange County

The ill winds of the housing market are having far-reaching effects on commercial real estate in Southern California, where some economists predict home prices may nosedive up to 30% from their most recent peak.

Orange County, in particular, is one place where the fallout from the bad news in the home building and mortgage lending industries is beginning to put a big dent in the local office market.

“Orange County was the epicenter of the subprime lending industry,” says Steve Economos, a principal in the Economos Group. Dozens of firms that originated high-risk mortgages are — or were — based in the affluent county south of Los Angeles.

Watching subprime lenders in their death throes has become sort of a spectator sport. The Orange County Register has published a running tally of the firms affected. At least 17 companies have either ceased wholesale mortgage lending or closed altogether as of January 2008, laying off more than 8,000 workers.

“We benefited disproportionately from the mortgage industry,” says economist Esmael Adibi of Chapman University, “and now we are getting hit disproportionately hard.”

As a result of the housing market freefall, Orange County office vacancies have risen from an enviably lean 7.91% at the end of 2006 to a pudgy 12.43% in the fourth quarter of 2007, according to Voit Commercial Brokerage. When sublease space is added, that figure balloons to 17.07% vs. 11.5% a year earlier.

Finance and construction-related tenants have put nearly 1 million sq. ft. back on the sublease market. The result is “upward pressure on vacancy rates and downward pressure on rents,” according to Adibi, director of Chapman University's A. Gary Anderson Center for Economic Research.

Another 4 million sq. ft. of new office space came on line in the market during the past two quarters, just as the troubles caused by subprime lending began to wreak havoc on the local economy and the capital markets. “It's a perfect storm on the negative side,” says Economos.

Chapman University's annual economic forecast reports further discouraging data for Orange County. Thousands of jobs in the construction and financial sectors have disappeared. The unemployment rate in Orange County rose to 4.3% in December, up from 3.1% a year earlier. Statewide, job growth in California may be a mere 0.1% this year.

If Orange County is feeling the chill of recession already, the rest of the country may not be far behind. Chapman forecasts that securities backed by residential mortgages may lose $350 billion of their value. “This loss in paper wealth is expected to lead to a significant decline in consumer spending, and further credit tightening,” according to the report.

UCLA economist Stuart Gabriel, director of UCLA's Richard S. Ziman Center for Real Estate, agrees. He says that the retail sector may continue to suffer in the coming year, especially in neighborhoods with a large number of starter homes that typically have a high concentration of subprime loans.

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