Office Keeps a Slow, Steady Pace

The majority of the leasing activity and positive net absorption has occurred in the Class A market, particularly in the Central San Diego suburban markets. About 85 percent of the absorption over the past three years has been in the Central San Diego office markets, including UTC, Sorrento Mesa, Kearny Mesa and Del Mar Heights. Overall, the Central San Diego office market vacancy sits at 9 percent. As a result, building owners of Class A buildings in these select markets have been able to lower concession packages and hold tight on rents when compared to the previous few years.

Lease rates have also stabilized and are poised to increase as the supply tightens for quality space. Class A asking rates had an overall average of $2.58 per square foot (full-service gross) at the end of 2012. This was unchanged from the previous two quarters while Class B asking lease rates increased by 5 cents to $2.05 per square foot over the second half of the year. Class C space also saw an increase from $1.46 to $1.55 per square foot over the same period. This trend is indicative of an improving office market. Class B and C building owners begin to benefit from rising rents as concessions fall in Class A space and tenants seek more affordable options. Coupled with limited new construction, San Diego’s overall office rent growth is projected to increase by more than 5 percent annually over the next five years.

San Diego’s major employment drivers over the next five years are expected to be found in the education and health services (3.5 percent), leisure and hospitality (3.3 percent), and professional and business services (3.1 percent) sectors. Coupled with the lack of new speculative construction, the overall vacancy rate for the entire San Diego office market is expected to decrease to less than 12 percent by 2014. Employment levels among San Diego white collar industry groups are forecasted to grow 3.3 percent annually through 2016, leaving San Diego poised to experience significant job growth.

The San Diego investment volume was slow throughout 2012, with only a small handful of notable institutional sales occurring during the year. In Downtown San Diego, Diamond View Tower, Columbia Center, 600 B Street and 655 West Broadway all traded to new ownership groups with the buyers taking advantage of valuations at well below replacement costs. With most office buildings near or at trough level leasing metrics, most owners elected to continue holding their assets as the evidence of a recovery was underway. This will positively impact office building values into 2013 and beyond. As the positive impact of job growth is realized by increased rental rates and lower vacancy metrics in 2013, office building owners will be in a better position to realize gains in office building values.

– Nick Psyllos, Senior Managing Director, HFF