The Inland Empire office market is in recovery mode

It’s just not recovering as quickly, or as comprehensively, as most real estate professionals would like. While there is reason for some optimism, don’t look for any “spec” office construction in Riverside and San Bernardino counties this year.

As 2015 begins, the Inland Empire office market is in much the same place it was exactly one year ago.

There’s a lot of vacant space sitting on the market, and there’s a good chance some of that space will be filled during the next 12 months. Also, landlords are no longer offering major concessions, like six months free rent or exorbitant breaks for tenant improvements, to get tenants to sign on the dotted line.

But there’s little construction on the horizon, and no signs of any speculative development, which is the sign of a truly robust market. The bottom line is simple: developers aren’t going to build anything new as long as there is so much empty space waiting to be filled.

Conventional wisdom among real estate professionals says that a region’s office market is always the last sector to come back after a recession, Residential and retail always lead the way, followed by industrial, then office. By that standard, the Inland office market is still fighting to recover from the body blow it received when the recession hit in 2008.

Still, there’s reason for optimism as the new year begins.

“I really believe that the Inland office market is going to do well in 2015,” said Rick Lazar, senior vice president with Coldwell Banker Commercial Sudweeks Group in Redlands and a longtime office broker in the Inland market. “I don’t expect it to be anything like the industrial market, but I still think it will do well, and it should improve.”

Not that 2014 was necessarily a bad office year in the Inland region.

During the third quarter, the two-county region’s office market had a vacancy rate of 13.9 percent, down 3.5 percent compared with the third quarter of 2013, according to Voit Real Estate Services.

Nationally, the office vacancy rate during the third quarter was 11.2 percent.

Asking lease rates in the Inland Empire were stable: $1.74 a square foot in the third quarter of 2014, down one cent year over year. Net absorption for the region was 43, 253 square feet for the third quarter and 257,616 square feet for the first three quarters of 2014, according to Voit.

Total transactions posted positive numbers: 1.2 million during the third quarter of 2014, up from a little more than one million transactions during the same quarter of 2013, a 24.8 percent increase.

On the west end, the Ontario-Rancho Cucamonga submarket was dominant, with net absorption of 160,569 square feet and 20,475 square feet respectively during the first nine months of the year. Both markets, however, were saddled with high vacancy rates: 19.4 percent for Ontario and 12.4 percent for Rancho Cucamonga during the third quarter.

On the east end, Riverside tallied 88,334 square feet of net absorption for the first three quarters and a vacancy rate of 12.9 percent during the third quarter of 2014, followed by Corona-Norco, with 9,649 square feet of net absorption and a vacancy rate of 16 percent, Voit found.

Perhaps the region’s construction numbers were the most revealing.

Only 94,510 square feet of office space was under construction at the end of the third quarter, and most of that was in Ontario. Only 168,000 square feet of new office space went online during the first nine months of 2014, according to Voit.

Despite some negatives, the overall outlook is still good.

“Cautious optimism prevails,” concluded the Voit report. “Job creation will need to continue in order to drive the demand needed to sustain growth in the Inland Empire office market.”

Some long-term trends were more encouraging. The two-county region has recorded more than one million square feet of positive net absorption of office space during the last six quarters, and slightly more than two million square feet since the second quarter of 2011, the best numbers posted in those categories since 2007, according to Voit.

The basic fundamentals needed for the local office market to recover are in place, starting with job growth and an improving housing market, said Tom Pierik, senior vice president with Lee & Associates Riverside.

“The one thing I would like see in 2015 is more market absorption,” Pierik said. “But I still think the market has moved in a positive direction during the past, and that it’s in a lot better shape now than it was last year at this time. There’s a recovery, it’s just been slow.”

Pierik knows all about that slow recovery firsthand.

Since the spring of 2012, he and Dave Mudge, also a senior vice president at Lee & Associates, have been marketing Citrus Tower, a six-story building next to Interstate 215 in downtown Riverside.

Rents start at $3.10 a square foot, well above average asking rates in area, but Citrus Tower is on par with the best office buildings in Los Angeles or Orange County. Its location is ideal, and its top floor offers a panoramic view of the inland region.

In a good market Citrus Tower probably would have filled up quickly, but to date it has landed only two tenants: the law firm Best, Best & Krieger and CaLSTRS, a pension advisory firm for the California Teachers Union.

CalSTRS has signed a lease to occupy 8,000 square feet and is scheduled to move in next May, Pierik said.

The Inland housing market won’t truly come back until the housing market comes back, Lazar said.

“When that happens the title companies come back, the mortgage and escrow companies come back, all of the businesses that are connected to the housing industry will come back,” Lazar said. “And they will all need office space.”