Financial firms have become the Achilles heel of the Orange County office market in Southern California as the industry continues to shed jobs and consolidate operations. Over the past eight quarters, the county posted negative net absorption of 3.4 million sq. ft, including 691,274 sq. ft. in the first quarter of 2009. The vacancy rate has risen from 13.78% to 15.58% over the past year while asking rents have fallen 13.1% during the same period.

Still, the long-term outlook is far from gloomy. Orange County's diverse economy includes the growing high-tech, biotechnology and health care sectors. These juggernaut industries are expected to boost employment opportunities and help trim vacancies in the quarters ahead. Peter Castleton, senior vice president of Voit Commercial Brokerage, has 23 years of experience chasing deals as a broker in Orange County. NREI spoke with Castleton about the volatility in the office sector and the investment outlook for the rest of 2009.

NREI: Has the recession's impact on the office market yielded any surprises?

Castleton: It hit different sectors harder than others. Small building sales for the last two quarters were virtually dead. Those were the 5,000 sq. ft. to 10,000 sq. ft. office condos that were hot in 2006 and 2007. Small business entrepreneurs who looked to their Charles Schwab accounts or their home equity lines to finance building purchases found that their investments were down 50%. So, all of the equity that they had built up to purchase these small office condo projects got wiped out.

Developers who purchased and built some of these projects got burned. They bought these properties at very low cap rates with the expectation that they could put a condo map on the project and sell the units at prices that were 60% to 80% higher. But there was no demand. Those are some of the first projects that are back with the banks and being evaluated.

NREI: What accounts for the dearth of office building sales?

Castleton: Fear. Where is the bottom of the market? If investors have $100 million in the bank and they're looking to invest, there is no way they're going to jump in the water right now. What they would consider doing is buying a note [at a discounted price].

NREI: You've made the point that a wave of real estate owned (REO) properties will come to market this summer. Then what?

Castleton: Over the next 12 months, you will see more properties for sale. Prudential Real Estate Investors is ahead of the curve. It's disposing of $1 billion in commercial real estate assets, a combination of office and industrial properties. Chapman University recently purchased a 115,020 sq. ft. Class-A building at the Irvine Spectrum from Prudential at a very aggressive price (an estimated $20 million).

NREI: Long term, why are you bullish on the Orange County office market?

Castleton: In South County, you've got University of California, Irvine, which is a big contributor to the tech and biotech community as far as jobs and research. We've got the California State University system. Chapman College is another major contributor. The March unemployment rate in Orange County was 8.5% compared with 11.2% for the state. We're outperforming the market, and I think that we will continue to do so.