Don Mitchell, Cresa in San Diego
San Diego’s core commercial office markets continue to tighten. Less than 1 million square feet was added last year, while more than 1.2 million square feet was absorbed. In 2014, construction commenced on the first speculative high-rise office project since Hines’ La Jolla Commons I in 2008. The Irvine Company plans to deliver a 306,000-square-foot, Class A development called One La Jolla Center in UTC this year. This project follows on the heels of the adjacent 415,000-square-foot, build-to-suit for LPL. This activity points to a strengthening market as developers, equity partners and lenders believe the benefit outweighs the risk of speculative development. Sorrento Mesa also received 410,000 square feet of new office space at 10001 Pacific Heights Blvd. last year that was pre-committed by owner-user Qualcomm.
The overall vacancy rate for the core markets in three San Diego regions (Downtown, Central and North County) was reduced to 11.5 percent by year’s end, indicating a tight market for users. Rent spikes can be anticipated when vacancy rates shrink to single digits. This should occur this year in submarkets like the Uptown area (5.5 percent), Poway (5.4 percent), Rancho Bernardo (6.8 percent), North Beach Cities (5.7 percent), Torrey Pines (8.0 percent), Sorrento Mesa (9.9 percent) and Kearny Mesa (9.8 percent).
Submarkets yet to benefit from the recovering economy include Downtown (14.8 percent), Scripps Ranch (17.4 percent), Governor Park (17.8 percent), UTC (17.0 percent), Del Mar Heights (14.0 percent), Carlsbad (14.7 percent), Oceanside (14.1 percent) and Vista (18.1 percent). These vacancies have dropped consistently, however, and are expected to decrease further in 2015.
Class B product represents the softest pocket, with a 13.9 percent vacancy. Class B vacancy Downtown sits at 21.8 percent, while North County submarkets are at an average of 17.6 percent vacancy. Companies looking for well-maintained and centrally located space will have opportunities in the Class B office markets this year, while businesses looking for high-end, Class A space will pay the price. Class A vacancies for Central markets are between 5.7 percent to 7.7 percent and dropping. Businesses that relocated to Class A office space when the rates were near rock bottom will have to determine whether they want to pay the historically higher rates or relocate back to the Class B projects. It will be interesting to see if a substantial shift occurs in the Class A and B vacancies as the year progresses.
Over the last few years we have seen a significant response to the changing work environment. With business culture now focused on collaboration, employee retention, efficiencies in travel time and a new workforce generation, landlords are converting standard office space and traditional industrial space to accommodate this new culture. These strategies were successful due to the pent-up demand, though there are some concerns. These modified facilities require costly on-site amenities, services and tenant improvements. There is also a risk that this demand may not be long-term, but merely a trend. Copy cats have also become more the rule than the exception, so over time we expect to see a large supply of these opportunities and a softening of current rents. One current issue surfacing is the amount of parking available to businesses occupying converted industrial space. These properties have traditionally had parking ratios that are one-half the ratio required by office businesses. While there is hope that short commutes or public transportation will ease the need to drive to work, we don’t believe the habit of driving one’s car to work will change to any great degree in the short run.
By Don Mitchell, Managing Principal, Cresa in San Diego. This article originally appeared in the February 2015 issue of Western Real Estate Business magazine.