San Diego Still Growing

Erin Cassin is a contributor to Real Estate Southern California, from which this article was excerpted.

After a decade of working in Downtown San Diego, spouses and business partners Yehudi and Pam Gaffen finally decided to take up residence there three years ago.

“[We] considered moving Downtown twice in the past–formerly in the ‘80s and then late ‘90s–and both times elected not to do it,” says Yehudi Gaffen, who is a principal and co-founder of construction consultant firm Gafcon Inc. “But I guess once our kids left for college, it just felt very natural to come Downtown, and based on where things were at with the activity and the restaurants and culture, it almost was a no-brainer.”

The Gaffens are among thousands who have moved Downtown in recent years, as the population there increased from 17,513 in April 2000 to 28,314 in January 2006, according to the San Diego Association of Governments (SANDAG). This influx of residents is due largely to the redevelopment efforts that have caused a considerable change in both the look and feel of Downtown.

It is Downtown’s multifamily sector that has experienced the largest surge, development-wise, in the past six years. According to SANDAG, the number of multiple family housing units here increased from 8,973 in April 2000 to 16,432 in January 2006.

Bosa Development Corp., which began its first Downtown San Diego condo project, Horizons, in 1998, was one of the first residential developers to build here when the recent wave of redevelopment began. “I think one of the rewards of Downtown San Diego is all that has happened and is happening down there that enhances residential living,” says Dennis Serraglio, Bosa’s director of sales and marketing.

The success of the Vancouver, Canada-based firm in Downtown has attracted other faraway developers, such as Levin Menzies & Associates LLC of Walnut Creek. “I’m the acquisitions manager, so I got involved in San Diego, saw the emergence of the ballpark and the work that CCDC was doing there and saw the success of Bosa with their condominium projects,” says Richard Garcia.

His firm eventually acquired the East Village’s historic Carnation Building in 2002 and is currently incorporating the facility into its 385,000-sf Icon project, which will be comprised of 327 condominium units, 16,000 sf of ground-floor retail space and three floors of underground parking.

Icon is currently Levin Menzies’ sole Downtown project; although Garcia says the firm has been looking at some local additional acquisitions. Likewise, most developers active in the Downtown condo market are focused on finishing up their projects and not planning new construction starts here anytime soon.

This slowdown in starts is reflective of the overall cooling in the condo sector that has occurred not just in Downtown San Diego, but in California as a whole. Sales have dropped statewide, as illustrated by statistics from the California Association of Realtors, which show a 17% decrease in condo sales between June and July of this year. In addition, the median price of a condo dipped to $422,590 in July, which represents a 1.9% drop from June, according to CAR.

When it comes specifically to Downtown San Diego, some developers project that prices are going to flatten, but not decrease significantly. “I think that prices are basically going to go flat for the next year and once buyers realize that the prices aren’t going to significantly drop, then I think you’ll see some small increases in prices, probably as early as the middle of next year,” says Robert Champion, president and founder of Los Angeles-based Champion Development Group.

San Diego-based OliverMcMillan is one developer that plans to tap into the continued demand for apartment product in Downtown. The firm is currently working on three separate mixed-use projects that will deliver a total of 454 apartment units and about 30,000 sf of retail space to the market.

“We felt that much of the rental inventory had been chewed up with condo conversions in the Downtown area and there was a niche–at least a temporary niche–for building A-grade apartments Downtown,” says OliverMcMillan’s managing director Jim Reynolds. “Not much product has been built and there’s a good rental market in San Diego in general.”

Rising construction costs are also contributing to the slowdown in condo development here, Champion explains. “[Condo] prices need to rise, not only at a rate sufficient to cover the cost increases that have been incurred in the last two years…but to then rise above that amount so that there is a profit incentive to build. So I think that that could be five years out.”

Champion’s firm recently completed the adaptive reuse of the historic Samuel Fox building into 7,500 sf of retail space that is occupied by a Club Sushi restaurant, 21 for-sale live/work lofts and two office condos.

“Even though the condo market has cooled, the office market Downtown is very tight,” Champion says. “We’re seeing a growing trend in the marketplace [of] office condos being built and sold. In essence, these work/live lofts allow people who have small businesses to be able to buy their office space.”

Additional office condo space, minus the residential component, has recently been delivered to the Downtown market as part of Cruzan/Monroe’s redevelopment of the historic TR Produce warehouse. The project is composed of 28 office condominiums and 19,000 sf of retail space.

The next office condo project slated to come online Downtown is MetroWork at 1350 Columbia, which will be completed in February 2007. The project, which is being developed by Berkson Realty Advisors LLC, will consist of 27 office condominiums and approximately 14,000 sf of retail space that will serve as a restaurant and music venue. “We’re the first new construction [office] condo development in Downtown,” notes Howard Berkson, the San Diego-based firm’s managing member. “Building from the ground up allowed us the freedom to create open, contemporary floorplans ranging in size from 1,200 sf to 8,000 sf.” Thus far, more than 80% of the units have sold.

Having seen the positive reactions garnered by TR Produce and MetroWork, redevelopment specialist Sand & Sea Equity Group LLC has also decided to bank on office condo product with its Gateway Office Centre project. “We’re piggybacking on a couple of projects that have had tremendous success in Downtown,” says Malcolm Davies, a principal with San Diego-based Sand & Sea Equity Group. The firm’s project, which is slated to begin this November, will entail the renovation of the former Chicago Title building into office condos and a ground-floor retail component.

Downtown San Diego’s office sector has also attracted investment on a much larger scale, as the Irvine Co. has purchased six class A office buildings here over the past several years.

Even with the Irvine Co.’s entrance into the office market, however, occupancy levels have remained fairly even here. “It’s been exciting over the last 24 months because of what the Irvine Co. has done and all of the buildings trading hands and the new buildings coming out of the ground, but it’s kind of steady as it goes,” says Mike Macie, a director with Cushman & Wakefield’s San Diego branch.

Although Cushman & Wakefield research points to a decrease in the Downtown CBD’s overall vacancy rate from 11.06% in the first quarter to 10.4% in the second quarter, Macie and colleague Steve Rosetta attribute much of the demand to tenants that were already located here.

“It seems like a lot of chess pieces Downtown [are] just moving around, rather than [adding] new tenants to the market,” says Rosetta, executive director of Cushman & Wakefield’s San Diego branch.

While the Downtown office market has seen little change in its tenant mix, the retail sector has begun to experience some variation in recent months. “We’re seeing definitely a shift,” says Bill Shrader, a senior vice president with San Diego-based Burnham and founder of the firm’s Urban Retail Group. “This has always been a strong restaurant and entertainment market, but now retail is coming.”

The Downtown retail market has firmed up in recent months, as Burnham statistics cite a 6.6% mid-year vacancy rate that reflects 39,428 sf of positive net absorption for the first six months of 2006.

And while the retail sector continues to heat up, the hotel market is still performing robustly. “We continue to have such a strong convention and group meeting demand… so Downtown is doing very well,” notes John Kratzer, president of San Diego-based JMI Realty LLC, which sold the 235-room Hotel Solamar for $87 million to Bethesda, MD-based LaSalle Hotel Properties this past summer.

Indeed, Downtown San Diego’s growth is expected to continue well into the future, in all sectors of the market. In fact, one of the largest commercial projects left to be developed is currently moving through the planning stages and may begin construction as early as next year. The mixed-use project, known as Manchester Pacific Gateway, will entail the redevelopment of Downtown’s Navy Broadway Complex. Upon completion, it will encompass 1.8 million sf of office, 1.2 million sf of hotel and about 180,000 sf of retail space, according to Douglas Manchester, founder and chairman of San Diego-based Manchester Financial Group.

“It’s still a work in process,” notes Manchester, who says he envisions something similar to the Time Warner Center in New York for the Manchester Pacific Gateway project. The developer plans to begin construction on the project’s first building, the Navy headquarters facility, within the next six months.

With the Manchester Pacific Gateway and many other projects still in the planning stages, Downtown San Diego still has a lot more room to grow. As Nancy Graham, president and COO of Centre City Development Corp. asserts, “I would say maybe we’ve gone a third of the way and that means that we have a lot more opportunity to even get better.”