Local Office Market Grows Across All Classes

SAN DIEGO—Cassidy Turley reports that San Diego County office tenants absorbed 650,000 square feet during the third quarter with positive activity across all classes – a trend not seen since the same quarter last year.

The Cassidy Turley report shows that year-to-date total countywide office absorption of 566,000 square feet countywide is down from 880,000 square feet, or 35%, from the first three quarters of 2013 – the direct result of 545,000 SF of class B space returned to market during the first half of this year.

“While overall office absorption is down from last year due to the influx of vacated class B space, class A net absorption totals 651,000 square feet for its highest level since 2007,” said Brett Ward, managing director. “With the exception of first quarter 2013, class A leasing has been positive for the past 20 quarters during which tenants have absorbed 4.2 million square feet or an average of 210,000 square feet per quarter. Consequently, countywide class A direct vacancy has decreased 790 basis points (bps) from its peak rate of 19.4% recorded more than five years ago to 11.5% today.”

Overall, class A vacancy across all Central County submarkets was 10.2%, the lowest in San Diego County and trailing South County at 13.4% vacant and North County, which has 15.2% vacancy. In some of the most popular Central County submarkets, class A supply is quite limited as evidenced by current single-digit vacancy rates of 3.7% in UTC, 5.7% in Kearny Mesa and 7.8% in Mission Valley.

“As class A supply becomes more limited, overflow demand to Class B space will lower vacancy in that segment as well,” said Duncan Dodd, senior vice president. “Flight-to-quality and renewals within the 5,000 to 30,000 square foot range will continue to be the main drivers of leasing activity, accounting for 40% of total lease obligations set to expire in 2015. Leases 5,000 square feet and less will account for 23% of expirations in 2015.”

Class B tenants absorbed 356,000 square feet during the third quarter of 2014, most of which is located in Central County. This activity drove vacancy in this sector to 17.6%, down from 18.7% the prior quarter and 230 bps lower compared to the peak rate of 19.9% recorded more than three years ago in second quarter 2011.

The Cassidy Turley report shows that countywide office vacancy including sublease stands at 18% as of third quarter 2014, down 60 bps from 18.6% the prior quarter. Direct vacancy for all classes, excluding sublease space, was 14.6% as of September 30, 2014, down from 15.5% in the second quarter and 340 bps lower than the peak vacancy rate of 18% recorded at the end of the recession.

Notable tenant move-ins during the third quarter included the occupancy of 47,000 square feet by Intercept Pharmaceuticals in Eastgate; the occupancy of 36,000 square feet by Interpreta in Torrey Pines; the occupancy of 27,000 square feet by Biotox Sciences in Sorrento Valley; the occupancy of 22,000 square feet by Altrium in UTC; and the occupancy of 20,000 square feet by Art of Problem Solving in Rancho Bernardo.

The largest move-outs occurred in the Point Loma/Sports Arena submarket, where BAE Systems vacated 56,000 square feet; in Rancho Bernardo, where Astute Networks and Kodak vacated a combined 27,300 square feet; and in Governor Park, where Kleinfelder vacated 25,600 square feet.

“Looking ahead, a number of large leases were signed in the third quarter that will positively affect absorption in future quarters,” said Bill Cavanagh, senior vice president. “In Rancho Bernardo, over 80,000 square feet will be occupied by Cymer and Renovate America. Moss Adams and the University of California San Diego will occupy 40,000 square feet in UTC, and in Sorrento Mesa, Spreadtrum Communications and DefenseWeb Technologies will also occupy about 40,000 square feet of vacant space. Additionally, there are 263,000 square feet in already inked leases that are still yet to be accounted for in Eastgate absorption .”

The Cassidy Turley office report shows there are seven projects totaling 1.1 million square feet under construction countywide, 40.3% of which is preleased. Two of the new projects, totaling 341,000 square feet, are scheduled to deliverlater this year. The remaining five projects, or 735,000 square feet, will finish in 2015. The preleased projects include Sempra Energy Tower in Downtown San Diego and Bressi Ranch Lots 10 and 11 in Carlsbad, both of which are 100% committed, and Spectrum Lab in Torrey Pines, which is 25.7% pre-leased.

“While construction is on the upswing, many developers and their lenders are still reluctant to take the risk without strong pre-leasing in place, but they are beginning to discuss timing,” said Cavanagh.

The countywide average asking rent for all classes combined in the third quarter 2014 was $2.40 per month per square foot full service, 13.7% below the peak rate recorded nearly seven years ago in first quarter of 2008 but 4.8% higher than a year ago. Class A rent has also increased 6.2% over the past year, and class B rent has increased 4.1%.

“In 2015, all San Diego County employment sectors combined are forecasted to grow 2.3%, or 31,100 jobs, with the professional and business services sectors expected to grow by 3.6% or 8,250 jobs,” Ward said. “This will positively affect demand for office space. Hiring in the office sector will move the San Diego vacancy closer to market equilibrium with overall vacancy rates between 10% and 12%. San Diego has added 118,300 jobs since the end of the last recession in June 2009, which is 36,800 jobs more than the 81,500 jobs lost during the last recession.”

“Already, tenants in the market are looking for 4.2 million square feet over the next 24 months countywide,” he said. “While not all of the current tenants in the market will transact in the short-term, leasing activity is certainly poised to strengthen further.”