If anyone needs another sign of the strong industrial demand in San Diego, look to the construction pipeline. According to research from JLL, last year the San Diego market saw the largest number of new industrial deliveries since 2001. There were 15 projects delivered in the market, totaling 2.5 million square feet, close to the market record of 2.7 million square feet in industrial deliveries in 2001. Industrial demand has fueled the new development activity.

“A lack of supply in the market has driven new development in San Diego.  This is acutely evident in space larger than 100,000 square feet,” Andy Irwin, VP at JLL, tells GlobeSt.com. “Ten new leases were signed on buildings completed in 2018 or under construction. The largest transaction involved a 273,000-square-foot build-to-suit for Stone Brewing. With the robust leasing activity in 2018, we have very little supply of new space left countywide. Leasing activity has been very strong by companies in the ecommerce, logistics, and consumer products industry. Class-A industrial space has been in the highest demand prompted developers to scramble to meet this demand over the last two years.”

With a limited supply of new, class-A industrial space, the new supply is attracting strong interest from users. These users are willing to pay a premium to be in quality spaces. “By market segment, we have less than 100,000 square feet of space in new buildings or those that have broken ground in the South County, no space in Central county, and approximately 740,000 square feet in North County,” says Irwin. “We are tracking over 850,000 square feet of space in buildings set to be delivered this year with leases in place.  The new buildings are achieving rents from 10% to 30% above average rents for their respective submarkets.”

As a result of the new product, rent growth, which has already grown at a rapid pace, has accelerated even more. “This has helped to accelerate rent growth already buoyed by historic low vacancy rates,” says Irwin. “There is a vast difference in functionality that new buildings offer versus existing product. Stricter fire codes are pushing tenants to buildings with ESFR sprinkler systems which most existing buildings don't have.  Developers are delivering buildings with 32-foot clear heights or greater versus the last generation of buildings designed at 24 feet.  This is a 33% increase in cubic capacity, which in many cases will offset the rent difference between new and old buildings.”

According to the JLL report, there is another 1.8 million square feet in the construction pipeline. While there continues to be strong demand for more industrial product and rental rates that justify new construction, Irwin expects that construction activity will slow due to limited land. “We are almost out of industrial land in the county and the pockets where land remains have barriers to development,” he says. “The cost and time to entitle the remaining land sites will slow the pace of future development. There are a handful of projects in the county that are slated to start in 2019 but at a fraction to what we have seen over the last two years.  Land pricing and construction costs continue to rise which further compresses yields and reduces a developer's ability to make a project pencil.”

While this is the highest level of new construction activity since 2001, the market dynamics and drivers of new development are very similar. “Rental growth and an extremely low vacancy rate has driven the explosion in construction activity,” says Irwin. “Development activity across the county went on hold around 2009.  It remained that way for about seven years with only a handful of build-to-suits occurring during this period.”

The new construction activity rebounded a couple of years ago as demand for industrial space climbed, a combination of ecommerce and life science growth. “The pioneers ramped up a few projects in 2016 and by 2017 there was heavy activity in industrial land acquisition, design and permitting,” says Irwin. “This has resulted in the more than 3.5 million square feet that has been delivered or is under construction in the county. The big difference this cycle is that we have built far less space versus the last cycle, most of the space has been leased, and the existing demand dwarfs the supply of new buildings. Given the limited land supply, new construction starts will significantly decline in 2019. This should put continued downward pressure on vacancy.”