Class-B Office Most Popular in Coastal Markets

Class-B office properties are the hottest assets in San Diego’s coastal markets, both in terms of tenants demand and sales activity. According to new research from JLL, class-B asking rents have increased rapidly this year to $3.25 per square foot and increasing demand from value-add office investors to renovate dated assets and capitalized on the rising rents.

“Class-B office property is the biggest segment on the coast and represents over 65% of the coastal market compared to class-A, which accounts for less than 15% of the total stock,” Pascal Aubry-Dumand, VP at JLL, tells GlobeSt.com. “Secondly, class-A buildings are already well leased and have limited options available. The real reason for the solid performance of Class B office buildings is that several of them have been or are in the process of being repositioned and offer finishes and amenities that, until now, have not been available in the coastal market. The resurgence of areas like the Cedros District in Solana Beach and the recent high-profile sale of The Bungalows in Del Mar on Jimmy Durante Boulevard are a testament to the strong demand to come.”

Overall, the coastal office market rebounded in the second quarter with positive absorption of 17,687 square feet and a 92% occupancy rate. This was a break away from the past three quarter of negative absorption. Despite the gains, however, year-to-date absorption is negative 15,492 square feet. “Until recently, office product on the coast lacked appeal, and while sporadic repositioning was indeed happening, it was simply not enough to satisfy demand,” says Aubry-Dumand. “In fact, it wasn’t at all unusual for a tenant to target the Village of La Jolla or Del Mar Village and to abandon ship due to the lack of quality space, ending up in UTC or Del Mar Heights instead. 2018 and 2019 should constitute transformative years, with a lot more product being repositioned and delivered at the same time. In our opinion, pent-up demand is there and is stronger than ever, and the product is finally being delivered, with some owners repositioning assets in a more creative environment geared towards younger users.”

Sales activity this year is on pace to meet or surpass sales volumes of 2017, and most of the players in the market have been private capital sources. “Institutional buyers tend to stay away from the coastal office market due to the size of the assets,” says Aubry-Dumand. “Historically, the coast has always been well leased and buyers feel that it is a safe investment. Private investors find it attractive because of the quality of the tenants, but they are mostly attracted to it because of the lack of competition from major players like Irvine Company and Kilroy, to name of few.”

Rental rates growth, overall, hit 2.9% at $3.23 per square foot. Class-A asking rents are $3.55 per square foot. Even with slow leasing activity, rental rates are continuing to rise. “With good fundamentals, owners are investing money in properties to attract and retain coastal tenants,” adds Aubry-Dumand. The market is extremely tight, so once a new property is repositioned, coastal tenants tend to be attracted to it. We are seeing a real appetite for value-add properties in general and for well-located Class B buildings offering good curb appeal. Rental rates are being pulled up by these value-add investors. Only time will tell, but in our opinion, investors will get what they are asking for. Quality product is still quite rare, and in comparison to what markets like Carlsbad, Del Mar Heights, UTC and Downtown San Diego have to offer, the coast is a gem.”