First Spec Office Development in Years

SAN DIEGO—It's been about seven years since the San Diego market has seen it, but speculative office development is back and more deliveries are expected in 2015, JLL's EVP Tony Russell tells GlobeSt.com exclusively. We spoke with Russell after the firm released its first-quarter 2015 office report to find out his take on office completions, projects under construction and the factors influencing office construction in San Diego.

GlobeSt.com: Office completions were strong in 2013, but not as strong in 2014. What do you expect to see in office completions this year?

Russell: In 2013 and 2014, the majority of the construction was projects like the LPL Financial 400,000-square-foot build-to-suit. This year, we will see a lot of projects completed, including two spec office projects that are under construction: the 306,000-square-foot One La Jolla Center, which should be completed by the Irvine Co. in mid-summer, and the Heights Del Mar, a 75,000-square-foot project to be completed by Kilroy Realty in the fourth quarter of this year. Then, there's the Sempra building Downtown, which is also a build-to-suit.

There's about 320,000 square feet under construction that will be done in the next few months. In Carlsbad, Cruzan is doing a redevelopment of an older industrial building to create a unique creative-office project called Make. All of these projects will be delivered this year, and those are really the new inventory.

Also in San Diego right now, there is a lot of repositioning of older project into creative. Enclave Sorrento is a 205,000-square-foot, class-B project that has undergone a major renovation and is now a class-A, state-of-the-art, creative-office project. We're working on the leasing of that project.

GlobeSt.com: Projects currently under construction appear to be in various North County submarkets and one in Downtown. What is preventing development in other areas of the county?

Russell: This is the first time in approximately seven years that we've seen brand-new spec office construction taking place. Over the past few years, there have been a handful of build-to-suits completed, but no speculative development. Class-A rents have been increasing at a rapid pace due to lack of available class-A space in the market. Some submarkets, like UTC and Del Mar, can support the new construction. Those two submarkets are achieving the highest class-A rents, and both of those markets have some of the lowest class-A vacancy, so developers can justify developing properties there. There's a lack of existing space, and they can get the rents that justify development, along with strong demand.

GlobeSt.com: What other factors are influencing office construction in San Diego?

Russell: Demand is influencing office construction because we have a very low vacancy rate. The biggest thing is over the past five years we've had very strong absorption taking place in the market. We've absorbed about 5 million square feet in the past five years in San Diego. The overall office vacancy here has declined from 17.5% to 12.5%, and class-A vacancy has declined at an even more-rapid pace of 18.5% to 9.4% today. We have single-digit vacancy in class-A countywide. The lack of supply is what's fueling all this redevelopment and new spec construction taking place in the market.

We're also seeing a lot of existing tenants in the market expanding. Companies weren't expanding for a while, but for the last couple of years, they've been expanding and taking more space. There are not a lot of new companies moving into San Diego—these are existing companies expanding their footprint. We're tracking more than a dozen office tenants who are looking for more than 100,000 square feet of space each in the San Diego market right now.

GlobeSt.com: What types of office renovations are being done now? Is it all creative office finally making its way down to San Diego?

Russell: Creative office has definitely hit San Diego. Creative office is a term that's kind of overused, but most tenants in San Diego—whether they're financial-services companies or a tech companies—want cool, creative, open, collaborative spaces. Even law firms today are going to more open spaces than they previously had. They still have private offices, but they want the nice, modern outdoor amenities. The weather is so great here that people want to be outside. They want the space and light, bright, open-ceiling concept along with more-modern finishes. Even in some of the more traditional, existing class-A office buildings, owners are going to spec out suites to fit that mold. I'm working on three or four projects right now that are existing office converting older, traditional office spaces into newer, cutting-edge creative spaces. Even the Irvine Co.'s One La Jolla Center has this, and they're getting good leasing activity from larger tenants. They leased a full floor to NewStar, and they're chasing two large law firms that would take two floors each. The Irvine Co. is taking two floors of a brand-new office building and making them multi-tenant—2,000 square feet to 6,000 square feet—creative-type spaces with a combination of open ceiling and more open finishes in UTC.

GlobeSt.com: What else should readers know about the San Diego office market?

Russell: The reason we're seeing spec construction now is that vacancy has declined at a rapid pace and rents are increasing at a rapid pace—class-A rental rates in San Diego in the past 12 months have increased by approximately 6.5%, and in markets with spec construction like UTC, class-A rents have increased 16% over the past 12 months. This is the first time in many years that landlords can justify building new buildings and making them pencil because they can get the rents to justify construction costs.