Office Market Has Weak Quarter, Leasing Expected To Increase
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SAN DIEGO-While recovery is on the horizon for San Diego’s office market, the first quarter gave the year an uninspiring start. After two years of healthy growth, with record-breaking leasing activity in 2010 and net absorption of 860,000 square feet in 2011, the office market hit a flat spot in the first quarter of 2012, according to a report just released by Jones Lang LaSalle.
However, the market is showing signs of recovery with declining vacancy rates, an increase in active requirements and improved transaction fundamentals (longer terms, higher rents and fewer lease concessions) vs. what was seen in 2009/2010, executives from Cushman & Wakefield tell GlobeSt.com.
JLL’s report indicates that leasing activity dropped 40% and the market recorded a minor occupancy loss with negative net absorption of 57,000 square feet. But tour activity has increased, and landlords like The Irvine Co. have begun to display their confidence in a recovery by raising asking rates in key submarkets.
Also noted in JLL’s report is a “flight to quality” in most submarkets, with tenants still capitalizing on the lowest rents in recent years and taking down the market’s nicest spaces at bargain-basement rates. The overall class-A asking rate is $30.84 per square foot, $24.12 per square foot for class-B properties. As a result of the flight to quality, an occupancy gain in the class-A market of 160,000 square feet was balanced by a near-identical loss of 185,000 square feet in class-B product. Some class-B owners have begun to experience upticks in tour activity as class-A options diminish, though that inventory continues to bleed tenants.
C&W executives say that overall countywide asking rents have stabilized. Over the last two years, tenants have taken advantage of historically low rents to upgrade their spaces or relocate to submarkets that were previously too frothy. This has put upward pressure on class-A asking rents, particularly in the central core submarkets such as UTC, Del Mar Heights, Sorrento Mesa and Mission Valley.
Scripps Ranch is also seeing increased activity and higher asking rental rates, but downtown, on the other hand, rents have been very flat, with overall leasing velocity slow in this submarket for the last few quarters, Eli Gilbert, senior research analyst for JLL, tells GlobeSt.com. This has presented opportunities for companies in class-B space to upgrade at a lower cost.
“Over the last three to four years, we’ve been seeing tenants that are strong enough and healthy enough to survive the [economic] environment take advantage of the downtown market by expanding or relocating,” Christopher Reutz, research director for the San Diego region at Colliers International, tells GlobeSt.com. “They’ve been looking at rents diminishing, and they’re finding competitive A space at B rates.”
According to C&W’s first-quarter office report, San Diego performed the same as its neighboring counties with a 1% drop in overall vacancy (including sublease space) to 15.8%, a 35% drop in leasing to 1.3 million square feet, and a third less occupancy gain from first-quarter 2011 of 74,359 square feet. The direct vacancy rate dropped to 14.1% in the first quarter, compared to direct vacancy of 15.3% in the first quarter of 2011.
“The main takeaway from the [occupancy numbers] in the first quarter is that we’re likely to see net absorption change to positive in the coming months and a measured increase in occupancy during 2012,” Gilbert tells GlobeSt.com. “The downturn is not representative of what’s going to occur in the remainder of the year.”
Also boosting optimism is the addition of 7,700 new jobs here over the last 12 months, which has been enough to make a sizable dent in regional unemployment since the peak of nearly 11% in mid-2010, JLL’s report says. Still, San Diego’s unemployment rate is 9.3% today, up from 9% last quarter—better than California’s current rate of 11.4%, but not as low as the nation’s 8.7%, both of which were increases over the previous quarter.
“One of the things we talk about is the different industry clusters and how they affect leasing,” Gilbert tells GlobeSt.com. “Technology, healthcare, biotech, and life science and education are all seeing a lot of activity right now. These are the sectors that are contributing most to positive growth and the recovery of the market.”
Construction activity is still flat—an empty pipeline when it comes to speculative development—but there is some build-to-suit activity taking place. C&W says that current construction activity consists of two build-to-suit projects—an office campus for the County of San Diego totaling approximately 300,000 square feet in Kearny Mesa, and a 248,882-square-foot office for the FBI in Sorrento Mesa—but the construction pipeline is beginning to see renewed activity in proposed office projects.
“There are a handful of tenants with large space requirements which cannot be filled with the existing inventory, indicating there will be increased construction activity forward,” Matt Carlson, senior director at C&W, tells GlobeSt.com.
For example, LPL leased approximately 415,000 square feet at the end of 2011 for a build-to-suit project at La Jolla Commons in UTC, which will break ground mid-2012, and Kilroy Realty plans to break ground on an 82,000-square-foot office/life science building in Sorrento Mesa with anticipated delivery in the second half of 2013.
“A number of developers are currently pricing and redesigning office development with achievable delivery dates of 2015 for build-to-suit or speculative large-block opportunities, which would coincide with the recovery of market fundamentals,” Chris High, associate director at C&W, tells GlobeSt.com.
The investment market here has been slow, with a large percentage of office buildings trading hands in the medical field including clinics, medical condos and MOBs, Gilbert tells GlobeSt.com. According to Colliers International’s first-quarter office report, three class-B properties and three class-C properties were traded during the quarter, ranging from 12,627 square feet to 253,676 square feet. The sales prices for the class-B properties ranged from $239 per square foot to $576 per square foot; the class-C properties fetched $79 per square foot to $119 per square foot.
“I do think the market’s looking forward,” concludes Reutz. “The numbers don’t seem to imply that—everything’s down—but we’ll probably post 1 million square feet of absorption for the year. Looking at what the demand level was for this quarter, we’ll probably have a similar level of absorption for the rest of the year, and vacancy will be down to about the 13% to 13.5% range.”
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