Absorption Slows in San Diego Central

SAN DIEGO—The San Diego County office market hit a speed bump in the second quarter of the year with 250,595 square feet of net negative absorption. According to Cassidy Turley, the dip follows six consecutive quarters of positive activity, during which time tenants absorbed 1.8 million square feet.

“The good news is that this absorption slide is a temporary setback for San Diego,” said Brett Ward, managing director with Cassidy Turley's in San Diego. “Leasing in the market continues to strengthen, and several large commitments will contribute to significant occupancy over the next six to 12 months.”

The Cassidy Turley mid-year report shows that Central County move-outs totaling 620,000 square feet were substantially offset by positive tenant activity totaling 532,000 square feet. “The traditional top performing submarkets of UTC, Del Mar Heights and Kearny Mesa saw very strong tenant momentum,” Ward said.

The major move-outs included LPL Financial, which vacated seven buildings totaling over 400,000 square feet in Eastgate with its relocation to UTC; JP Morgan Chase, which vacated 131,000 square feet in Rancho Bernardo; and Sony, which vacated 62,000 square feet in Rancho Bernardo as part of an announced downsizing effort. Other move-outs included Lockheed Martin and MedImpact Healthcare Systems, which left 46,000 and 32,000 square feet, respectively, in Scripps Ranch.

Positive tenant activity in Central County included LPL's relocation into 415,000 square feet in the newly completed La Jolla Commons II in UTC. In Kearny Mesa, NBC 7/39 purchased and will occupy a 52,000 square foot standalone building in Stonecrest, and the County of San Diego moved into 34,000 square feet. Additionally, Del Mar Heights reported the second highest net absorption in the county with 56,000 square feet, which included Cal Bank's move-in to over 18,000 square feet.
Notable leases that will positively impact net absorption in upcoming quarters include ServiceNow, with a 60,900 square foot commitment in Eastgate; Receptos, which will occupy 43,000 square feet in the new Spectrum Lab in Torrey Pines; and Miva Merchant, which is committed to 23,000 square feet at The Point in Rancho Bernardo. Of the 400,000 square feet vacated by LPL Financial in Eastgate, nearly 250,000 square feet has already been re-leased to companies such as Lytx, Revlon and Intercept Pharmaceuticals.

Although direct San Diego County office vacancy (excluding sublease space) increased from 14.6% to 15.5% in the second quarter, it still is well below the peak vacancy rate of 18% recorded in 2009, the worst year of the recession.
“The office market has turned the corner, with many areas already transitioning away from a tenant's market,” said Ward. “The second half of 2014 will be about continuing the growth trend and strengthening market fundamentals, both of which will move the San Diego office market into equilibrium with overall vacancy between 10% and 12%.”

The 350,973 square feet of second quarter class A absorption culminated 19 straight quarters of positive activity totaling 4 million square feet, or an average of 210,000 square feet per quarter. Class A vacancy of 12.2% compares to 19.4% in mid-year 2009. Areas with the lowest class A vacancy rates areUTC, 4.6%; Mission Valley, 7.5%; and Kearny Mesa, 7.6%.

“As class A supply continues to deplete, overflow demand will pursue Class B product, in turn lowering vacancy in that segment as well,” Ward said.

Cassidy Turley reports seven under-construction projects totaling 1.1 million square feet countywide. Two of these totaling 341,403 square feet will be completed by year-end, with the remaining projects (737,121 square feet) set to finish in 2015. To date, pre-leasing is limited to the new Sempra Energy Tower in Downtown San Diego and Bressi Ranch Lots 10 & 11 in Carlsbad, both 100% committed, and to Spectrum Lab in Torrey Pines, which is 25.7% pre-leased.

“While construction is on the upswing, the development drama is only beginning, and it is about who will be the first few developers to deliver a product that is in short supply. With a large inventory of older buildings and the limited availability of new office space, there is a high demand for new construction or re-development to meet modern office requirements,” Ward added.

Cassidy Turley data shows that 70% of San Diego office inventory was built before 1990.

The countywide average asking rent for all classes combined in the second quarter was $2.40 per month per square foot full service. This is up from $2.30 a year ago but still well below the peak rate of $2.77 recorded in the first quarter of 2008. Compared to the same period of 2013, class A monthly asking rent has increased 6.9% to $2.94, and class B monthly asking rent has increased 2.7% to $2.28.

“Looking ahead, the re-emergence of small businesses and large corporate tenant growth will continue to be the main drivers of new leasing activity,” said Ward. “Tenants in the market are looking for 3.9 million square feet over the next 24 months countywide, with central and south counties accounting for most of this demand. While not all tenants in the market will transact in the short-term, leasing activity is set to strengthen, further generating improved absorption and steadily declining vacancy.

Cassidy Turley is a leading commercial real estate services provider with more than 4,000 professionals in more than 60 offices nationwide, and headquarters in Washington, DC.