Downtown SD Stronger Than Last 30 Years

SAN DIEGO—With class-A office vacancy in the single digits and 200,000 square feet of absorption last year, Downtown San Diego is just one submarket here with a bright future, say speakers at yesterday's CREW San Diego presentation “Momentum in the Marketplace: Real Estate Perspectives for Key San Diego Submarkets.” CREW members and guests gathered for the luncheon presentation at the Sheraton La Jolla to get a pulse on the San Diego office market.

Moderator Brian Galligan, SVP of Kilroy Realty Corp., gave each panelist a chance to summarize office fundamentals in their respective markets, and the news overall was positive. Brett Ward, managing director of DTZ, said it's hard to find a full floor in UTC, with its sub-5% vacancy. While Del Mar Heights was the last submarket to go into the recession, it now boasts single-digit vacancy as well, along with increasing rents. Sorrento Mesa, primarily an industrial market, is benefiting from tech CEOs reimaging workspaces there, with 10 projects currently being developed in this submarket, Ward said.

“The capital markets are white hot in these submarkets. The Aventine traded at north of $300 per square foot,” and other projects are following suit, Ward said. “We are clearly in an expansion phase.”

Chris Williams, AVP with Colliers International, said, “There's a wave of optimism just hitting North County. Rancho Bernardo is on fire, with vacancy rates for class-B space at 8% and multi-tenant class-A space at 3%. Carlsbad, with its 5.5-million-square-foot base, is 20% vacant, so it's still a tenant's market.”

Williams pointed out that both markets are similar in size but have different dynamics. Carlsbad's coastal location makes it all about lifestyle, where workers go surfing on their lunch breaks and golf and life sciences companies reside. “There's been an influx of creative demand, with industrial being converted to creative office” in Carlsbad.

Meanwhile, the I-15 corridor is more about corporate users like Northrop Drummond, HP and General Atomics. “Creative office is just hitting Rancho Bernardo. Carlsbad has absorbed 100,000 to 200,000 a year” since the recession ended, Williams said; it started off with 30% vacancy and has whittled down to 20%. “The North County market is 20 million square feet, but it's different from the coast to inland.” Williams also said the capital markets in Carlsbad are on fire, with six to seven projects on the sale block ready to trade in the near term.

Matt Carlson, SVP with CBRE, said the Downtown market is “stronger than it's been in the last 30 years. Class-A property vacancies are in the single digits, and there was 200,000 square feet of absorption in 2014. The fact that the Padres are off to a good start also helps, and the East Village is strong. Apartments are coming online, and there's a trend of luxury condos in San Diego. DiamondView Tower is the most successful office product in San Diego and will reach $4 rents per square foot soon.”

Carlson added that the population of Downtown San Diego will double by 2021 to more than 50,000, which is really 250,000 if you count the areas surrounding the CBD. “There is double the number of 25-to-35-year-olds in Downtown as compared to the county as a whole,” and this cohort is well-educated, he said.

Like in other urban markets, densification is the name of the game in Downtown San Diego, where you won't see opposition to projects like Kilroy's One Paseo in Carmel Valley, which Galligan said was receiving heated opposition from a small minority. And unlike Chicago or New York, Downtown San Diego competes with the beach towns for residents, which keeps parking abundant although pricy.

The class-B office market in Downtown is now faring quite as well as class-A, however, Carlson pointed out. “Large chunks of class-B space are empty Downtown—a total of 23% vacancy in this product type.”

What doesn't remain vacant Downtown, however, are brick-and-timber buildings, which “everyone wants,” said Carlson. “We don't have a lot of it here, and the innovative companies want it.”

Office development is occurring Downtown, with new build-to-suits and one to three spec projects completing this year, Carlson added. “Life science may dip a toe in Downtown—look for a suburban tenant to go Downtown in the next 24 months.”

Misty Moore, VP of Jones Lang LaSalle, who approaches the market from a tenant-rep perspective, said the San Diego office market is “hotter than I've ever seen it” and that deals are uncertain from one day to the next because properties are changing hands so quickly and owners are re-evaluating their tenant rosters. “There are not a lot of large blocks of space available, and there are ownership transitions in many buildings. When talking to my tenant clients, I have to say 'today,' because the situation could change tomorrow.

Galligan asked the panelists to name the top amenities on tenants' wish lists, and Moore said parking—public transportation doesn't work—ride-sharing, hoteling and work sharing, as well as a good deli or restaurant in or near a building. “A sweet gym is nice, but tenants don't use them.”

Ward said most tenants want indoor/outdoor workspaces, Wi-Fi areas and highly amenitized gyms rather than standard ones, similar to the type Make in Carlsbad offers tenants. “It allows recruitment and retaining. So does the ability to walk to true amenities.”

Williams said his tenants want outdoor areas with barbeque facilities and employer-provided amenities such as catered lunch, dry-cleaning, coffee/drink service and yoga training, while Galligan pointed out that pet access is another hot amenity. Carlson said bike-sharing programs and balcony access are important to Downtown office tenants.

When asked which industry types are poised for growth in San Diego, Ward said communication, technology, medical device and life science. Tech is strong in the mid-cities submarkets of UTC, Sorrento Mesa, Del Mar and Eastgate, while firms recreational-product firms like Go Pro are looking in Carlsbad and will pay high rates for single-story buildings. “They're expanding the scope of where they're looking.”

Williams said in Rancho Bernardo he's seeing growth in the defense and financial-services sectors, while gaming is strong in Carlsbad with firms like Zynga that have been leasing there for five years. “We saw a resurgence of mom-and-pop businesses on the I-15 before, but we're not seeing a lot of that now except in Carlsbad, which is strong in startups for technology, life sciences and gaming.”

Ward said shared-workspaces users are strong in UTC and Downtown, and Regus has taken space in Sorrento Mesa; this type of space is the “antithesis to collaborative space,” he added.

Moore said more entrepreneurial women are sharing workspaces, particularly in Carlsbad, and that this type of business could be accretive to landlords' assets, “but the pressure on rates is hard on that business model.”