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

Quieter times have come to Downtown San Diego. In the past few years, high-rise condominium development has spearheaded the area’s growth–but this trend has cooled noticeably, according to many of the industry’s local players. Moreover, they say, Downtown San Diego as a whole is seeing less activity than in past years.

“I would say that overall activity in Downtown is pretty flat,” notes Andy La Dow of Grubb & Ellis/BRE Commercial Real Estate. “We’re coming off a negative net absorption of [about] 160,000 sf during 2006. This year, we’ve had year-to-date positive absorption of 120,000 sf [as of August], which gets us a little bit more to where we have historically been meeting in the past six years.”

According to La Dow, the failure of a large tenant to leave the downtown area has negatively impacted market activity. However, he says, there is more strength to be found in the class B market, which has seen increased activity as smaller tenants who are facing lease renewals and higher rents are looking to take the step down into B-class space.Though San Diego regional president of the Olson Co. Tony Pauker has not built in Downtown since 2003, he continues to regularly monitor the market. “From what I see…on the residential side, apart from a few exceptions, it’s pretty much on hold,” says Pauker, who also serves as chairman for the local Urban Land Institute District Council covering San Diego and Tijuana. “What’s changed is that the residential markets have slowed down both on the resale front, as well as from the new development side. Quite a few projects have stopped–not mid-construction, though there’s one or two where they dug a hole and stopped–but rather projects that never went under construction.”

According to the San Diego downtown redevelopment agency Centre City Development Corp. (CCDC), as of May there were 27 projects under construction in the Downtown area, 41 projects pending construction with development permits approved and 16 projects under review, with development permits pending. There were six projects completed in Downtown as of May, according to CCDC.

A few more high-profile projects include changes being mulled by Westfield in order to update and expand Horton Plaza, as well as the rehabilitation of Seaport Village’s old police headquarters by Terramar Retail Centers, a project which will transform the quarters into a mix of specialty retail, restaurants, and entertainment venues.

Condos Stagnant, Activity in Other SectorsOver the past few years, condominium development has been a boon for other Downtown sectors, according to Coldwell Banker Commercial Almar Real Estate Group vice president Ron Graves. Therefore, the recent condo slowdown may or may not mean bad news for the area’s other sectors, according to Graves.

“The prevalence of high-rise condominium development has been the primary driver of retail development in this area over the past four to five years, with many of these condos having a retail component on the ground floor,” he says. “Very little new retail development has been built on a stand-alone basis. Even though the development of new high-rise condos has come to a screeching halt lately, retail remains steady due to the nature of Downtown life. There is a lot of pedestrian foot traffic to keep demand for retail steady.”

However, Graves says, one of downtown’s disadvantages is its dependence on condo development. “Much of the area’s economic growth hinges on whether people will continue to move into the new condominium developments,” he notes, adding that another disadvantage is the high price tag of building downtown–which may in turn be adding to what Graves sees as stronger retail demand in surrounding suburban areas.

Like other industry players, Tammy Harpster sees Downtown residential activity slowing. “A [lot of] projects are in the final stages of construction, and lenders are reluctant to finance more of these large condominium projects until the current inventory of units is reduced,” says Harpster, senior vice president of Phoenix Realty.

While larger Downtown retail spaces are in short supply, with pharmacies and grocers competing for prime locations, Harpster says that retail as part of mixed-use projects has seen slow absorption due to high rental rates. Meanwhile, she adds, the industrial sector has been virtually pushed out of the Downtown area in favor of residential developments, which command a greater land residual price.

A Diverse DowntownJim Torti, a principal at the architecture firm Graham Downes Associates, is seeing more properties on the Downtown San Diego market–and less demand for them. “As far as I can tell, there’s not a lot of closing transactions or pending transactions,” Torti says. “We might be seeing that buyers are still holding out on higher prices, and sellers are not reducing prices, which is creating a glut.”

Like Harpster, Torti has also observed consolidation amongst class A Downtown space, largely due to purchases by the Irvine Co. However, with the exception of Diamond View Tower, a 14-story, 305,300-sf class A office tower near the Petco ballpark, Torti says that activity in Downtown’s East Village area has slowed. However, one notable–and controversial–project proposed for the area is a $1-billion, 1,650-room Marriott Hotel, which, if approved, would be built as part of the mixed-use Ballpark Village. The project has drawn an outcry from housing advocates who say affordable residential units are in order for the site.

Most of Downtown’s strength lies in its diversity, however, according to Torti. “There’s a lot of things happening in Downtown, and that’s a good thing,” he says. “There are different sectors and different opportunities for growth.”

Toward the FuturePauker believes it will take between three and four years before residential activity begins to pick back up in the Downtown market. “A couple of projects have [already] started to refocus on becoming hotels, which I think is a fairly easy transition,” he says. “You’ve got the parking and the modular [design] as a hotel opportunity. For the condo market to resume in Downtown, we’re going to have to see the existing inventory of resale, and especially the new stuff, become absorbed. We’re also going to have to see the rebalancing of the mortgage markets and some stability in the average market before the market starts to go again.”

In evaluating the Downtown market’s future, Graves starts with a series of questions, most of which concern the residential market: Will condominiums that have already been purchased actually be occupied? Will those condos serve as primary homes, or rather as secondary residences? And how many of these condos were built on demand versus a spec basis? The answers to these questions, he believes, will frame the Downtown market’s future.

At the end of the day, Graves says, the rays of hope are plentiful. “Ultimately, we believe that the housing market has seen its worst and that things will remain steady. We are seeing a lot of tenant interest from retailers in shopping centers that haven’t even come out of the ground, so we remain upbeat about the overall state of the retail market Downtown.”

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