— By Jerry Holdner, Avison Young — Southern California Region Lead, Innovation & Insight, AVANT —
The San Diego office market is starting to show signs of weakness. Unemployment remains low, but it is important to highlight that job creation has been uneven. The bright spot is that high-value-added jobs in a broad range of sectors, such as scientific research, medical products and pharmaceutical development continue to grow, which bodes well for San Diego.
We are still uncertain about a recession. It could be short and shallow like many are predicting, or we could be in for a period of monumental headwinds. Investment sales have retreated as interest rates increased, and office workers have been reluctant to return to the office. This has created an uncertain picture of our office market going forward. The rise and future uncertainty of the pace of inflation has caused many to take a “pencils down” approach. This has caused many to slow, pause or even halt their dealmaking, growth, capital investment and development efforts as the ability to borrow funds has become difficult.
San Diego’s office vacancy currently stands at 12.3 percent, and 18.9 percent of the total office market is available (including sublease space), totaling 18.8 million square feet. We are seeing more office product becoming available as many companies lower their space requirements based on the prevailing hybrid or flexible work environment.
Currently, sublet space is at a record high and is still increasing, despite some sublet space that came off the market in the downtown submarket recently. Sublease availability has reached 3 million square feet, which is a million more square feet than what was available a year ago. It is more than double the amount of space available before the pandemic when there was 1.4 million square feet available.
Most of the sublet space is coming from the finance, biotech and high-tech industries. The tech industry, one of the main drivers of office space occupancy, has been experiencing significant layoffs that has resulted in an unprecedented amount of sublet space on the market. It has also been a driver of the recent drop in rental rates. This will put upward pressure on the vacancy rate and downward pressure on lease rates going forward because some of this space will go back to the landlords as direct vacant space when the leases expire.
With lease rates softening, there has been a flight to quality, in addition to the ability to secure flexible and more affordable office opportunities for many tenants. Over the next few quarters, we anticipate construction slowing, more negative absorption, increases in vacancies/availability and very little, if any, lease rate growth as companies right-size their space requirements.