Insight

Continued Cautious Optimism

San Diego's Commercial Office Market Continues to Stabilize. Lack of New Development Affecting Vacancy Rates.

September 18, 2013

While San Diego’s commercial real estate office market continues to stabilize with net positive absorption (a modest 2.5 percent positive net absorption since the start of 2012), it still does not approach the activity of 2007. With “flight to quality” occurring in recent years, Class “B” product is 13.5 percent vacant and continues to lag behind “A” product (11.3 percent). The overall San Diego office market is currently about 11 percent vacant, but due to an overall lack of construction, vacancy rates are actually declining at a quicker pace than the commercial real estate market is recovering.

The overall decrease in vacancy has mostly been realized in San Diego’s central office markets, where rental rates are increasing. Sorrento Mesa, one of the tightest markets, is currently only 8 percent vacant. Still, in outer lying submarkets like Otay Mesa (15 percent vacancy) to the south and Temecula/Murrieta (13 percent vacancy) to the north, the recovery has been very slow. There is less tenant demand and effective rental rates are still approximately 30-40 percent below their 2007 levels.

With only moderate overall absorption and Class “B” product still on the rebound, San Diego remains a tenant’s market. Landlords are still offering fairly aggressive tenant improvement packages to reputable companies. With the market showing signs of life, however, now is the time for tenants to lock in rates and save over the long-term.

 

Developers Weighing the Risks

Pure speculative development remains almost non-existent in San Diego, with lenders and developers preferring to only move forward on projects with a substantial amount of pre-leasing. One such project is the I.D.E.A. District in the East Village of Downtown. A future development of Lowe Enterprises, this mixed-use project will contain 100,000 square feet of creative office space and is designed to attract high tech companies into the downtown market. While an interesting concept, Lowe Enterprises still awaits a pre-leasing commitment from at least one large and reputable anchor tenant. Until then, the project will likely remain on hold. This is true for the majority of proposed developments.

Fully pre-leased build-to-suit projects remain the most plentiful source of new construction in San Diego County. Hines is well underway on the construction of a 415,000 square foot high rise build-to-suit in University Town Center for LPL Financial. La Jolla Commons II, as it will be known, is going to be the largest net zero office building to date in the United States, and although it is already 100 percent leased to LPL, the building further solidifies UTC as a destination office submarket.

Another large build-to-suit project is underway in Sorrento Mesa. BioMed Realty Trust, Inc. owns a 31 acre site and Shire Regenerative Medicine is expected to take up to 250,000 square feet of space in the first phase. The combination of these two projects will help to keep thousands of jobs here in San Diego.

We are beginning to see the revitalization and repositioning of existing developments. In these cases, landlords are improving to the creative office space trend including organic common area finishes, more natural light, less overhead lighting, collaborative break areas and less private offices. In Del Mar Heights, TIAA-CREF is close to unveiling its most recent reposition project, Township 14. Located on High Bluff Drive, it will feature high-end interior finishes and detail throughout. According to TIAA-CREF, “this premier office space will undoubtedly become a landmark project.”

San Diego’s Commercial Office Market is truly one in transition. With limited land to build on, we will once again see demand meet or exceed new supply, but how soon is still being debated.  One thing is for sure, San Diego as a whole will continue to be a great place to live and do business and the central submarkets will be popular locations.

By Don Mitchell, Managing Principal, Cresa