SAN DIEGO—After another exceptional quarter of office demand, 2014 is poised to be the strongest year for overall net absorption since 2005, according to a report from Colliers.

The regional vacancy rate continued to decline for a fourth consecutive quarter, dropping just below 13% in Q3 2014.  The countywide average asking rental rate across all classes continues to trend upward for an 11th consecutive quarter.

The August 2014 San Diego County unemployment rate measured 6.2%, which was a 0.4% decrease from July.  Both the California and national rates decreased to 7.4% (-0.5%) and 6.3% (-0.2%), respectively.  As of August 2014, San Diego County experienced a year-over-year increase in non-farm employment totaling 34,200 jobs.  The combined industry sectors of “Professional and Business Services” and “Financial Activities” – the two predominant office-utilizing employment sectors – posted a net increase of approximately 7,700 jobs over the same period.

Downtown class A vacancy decreased by 31 BPS to stand at 16.1%, of which 14.9% was attributed to direct space.

In Q3, the overall suburban office market vacancy rate decreased from 12.5% to 12.2% and class A adjusted down slightly from 11.8% to 11.7%.  At 13.4%, Class B has the highest vacancy rate of all the suburban market classes, but this segment has been improving significantly.  The suburban submarkets of Campus Point (31.6%), Torrey Pines (22.6%) and Governor Park (21.4%) maintain the highest vacancy rates in the county.

Countywide class A vacancy decreased by 11 basis points in Q3 bringing the rate to 12.8%.  Net absorption (demand) continues to be quite strong for this segment and will continue to be so with over a million square feet of new construction becoming completed next year.  The Class B decreased by 51 BPS down to 13.8%.

New Supply

In Q3 2014, no new construction was completed.  Nearly 600,000 SF has been completed over the past nine months of the year with over 1.4 million SF currently under construction.  Construction is underway in Sorrento Mesa on a 410,000 SF build-to-suit for Qualcomm on Pacific Heights Blvd. along with an extensive renovation of the 205,000 SF two-building Enclave Sorrento. 

Additionally, construction progresses on Irvine Company's 306,000 SF One La Jolla Center in UTC and Cisterra's 320,000 SF build-to-suit office tower for Sempra Energy in Downtown.  Finally, the MAKE project in Carlsbad on Avenida Encinas consists of a complete renovation of the former Floral Trade Center from an industrial building to nearly 178,000 SF of creative office space.  Over 11.1 million SF of new construction is proposed countywide.  New speculative projects will continue to commence over the next couple of years as demand continues to be strong, vacancy continually falls and rental rates consistently increase.

Net Absorption

Countywide demand in Q3 2014 totaled a positive 293,656 SF of net absorption.  This was a slight improvement over the 267,388 SF of positive net absorption in the prior quarter.  Year-to-date, overall demand has exceeded 1.14 million SF of net absorption.  At the current pace, 2014 will post the most absorption of any of the past nine years.  The class B office segment saw the most demand during the quarter with 180,076 SF of net absorption.  The class A inventory recorded 35,744 SF of positive net absorption while the class C market gained 77,836 SF.  For the first nine months of the year, class A demand was the healthiest of all office classes, making up over 52% of the net demand – equating to 598,966 SF.  Since 2010, both market segments have performed well with class A demand reaching nearly 3.1 million SF and class B at nearly 840,000 SF.

The Central County is the only market area where any negative net absorption was recorded in any of its submarkets.  There were seven submarkets that recorded negative net absorption in Q3 with Mission Valley (-53,458 SF) and Carmel Valley (-39,492 SF) posting the most.  The biggest recorded vacancy in Q3 occurred when Active Network relocated from their headquarters at Seaview Corporate Center in Sorrento Mesa to Dallas.  As of the end of Q3, they had vacated approximately 82,000 SF.  UTC (+107,129 SF) and Kearny Mesa (+78,188 SF) recorded the most positive net absorption in Q3. 

Downtown San Diego (CBD) recorded positive net absorption of 24,202 SF.  Even though the last two quarters have seen an uptick in demand, activity has been slightly negative year-to-date with a negative 11,544 SF of net absorption.  Most of the CBD's net absorption occurred in Class A space which totaled 22,318 SF, bringing overall demand to a positive 73,979 SF year-to-date.

Overall net absorption for the suburban submarkets totaled a positive 269,454 SF. All classes remained positive, but the class B segment performed the strongest with 167,474 SF bringing the nine month demand to 456,940 SF.  Class A has had the most demand year-to-date in the suburban submarkets with 524,987 SF of absorption.

The countywide average asking rental rate for all classes posted a third consecutive large quarterly increase, jumping by $0.03/SF in Q3 to stand at $2.27/SF/month on a full-service basis.  This equates to an over 6% increase in the rate in just one year.  The countywide class A ($2.88/SF) went up by $0.02/SF and the class B ($2.18/SF) rate increased by $0.04/SF.  Over a one year period, this equated to an increase in asking rates of 6.7% in the class A and 5.3% in the class B.  The overall CBD and Suburban rates increased to $2.23/SF (+$0.01/SF) and $2.28/SF (+$0.04/SF), respectively.

Vacancy

The absorption trend continues to be consistently positive, with 17 of the prior 18 quarters pushing vacancy rates steadily downward.  The overall countywide vacancy rate dropped 36 basis points (BPS) during Q3 to end the year at 12.9%.  This is the first time the vacancy rate has been below 13% since just before the recession began (12.3% in Q2 2007).  The overall vacancy rate is comprised of 12.2% direct vacancy and 0.7% sublease vacancy. Compared to a year ago (Q3 2013), the rate has dropped by 121 BPS.  Looking forward, demand is expected to continue to be steady and vacancy is projected drop to nearly 12.5% by the end of 2014.

The Downtown (CBD) vacancy rate decreased by 23 basis points to stand at 18.5% at the end of Q3.