San Diego Office Rents Justify New Spec Development

The San Diego office market fundamentals now justify new construction activity, and it could mean a growing office construction pipeline this year. In the fourth quarter 2018, leasing activity and rent growth remained strong, setting the stage for more construction. For the year, office rents grew 9.5% for the year, a record high, while the vacancy rate fell to 11.5%, according to new research from JLL. New construction has already grown in San Diego, currently at 1.4 million square feet.

“We have seen declining vacancy rates over the last three years. Year-over-year, the decrease in vacancy wasn’t substantially different, but I think that trend line will continue into 2019,” Tim Olson, managing director at JLL, tells GlobeSt.com. “Plus, there was strong leasing activity in the fourth quarter that will put further downward pressure on vacancy rate. Lower vacancies and a lack of larger blocks of space in the central market will be a big factor in new construction, as well as continued leasing momentum and positive absorption from both the defense and life science markets. Those markets will continue to absorb larger blocks of space, with will in turn make supply less available. That will also drive additional new construction in the market.”

Rent growth is really driving the construction activity. The historically high rents are now offsetting increases in construction costs and land prices. “Year-over-year, there was record high rent growth for the cycle,” says Olson. “That is driven by the decreasing vacancy rate but also by continued capital markets activity. The Irvine Co. acquired a lot of assets in 2018, Sorrento Mesa had several properties transact, and other non-Irvine sales as well in the UTC submarket. Any time that you see price appreciation, that is going to follow suit with higher rent growth.”

San Diego’s most popular market will likely be the markets to see new construction activity. Those include UTC, Sorrento Mesa, Downtown and Del Mar Heights. “Downtown you are seeing markets with higher rents and more rent growth as far as the strength of historical rent growth and high watermark rents on existing product. I think that is where we are going to see some of the new construction,” says Olson.

There are already a handful of significant projects underway, including One Paseo, a 300,000 square feet in Del Mar, which is already 30% preleased with high-water mark asking rents, and a total of 600,000 square feet of new construction in downtown and more than 1.5 million square feet of planned office projects. “There are already projects underway. Right now, we have 1.4 million square feet of new supply under construction,” adds Olson. “In 2017, we were at 900,000 square feet under construction. A lot of that activity is redevelopment as well, and that adds to the number. Those projects are quicker to deliver and don’t require as much red tape.”