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Cautious Companies Keep Office Market Recovery in Slow Motion

Cautious employers and bargain-hunting tenants kept San Diego County’s office market in steadily recovering but slow-growth mode in the third quarter, and experts don’t expect the pace to accelerate significantly until the nation’s political and budget picture comes into clearer focus in coming months.

Bill Fleck, senior managing director in the San Diego office of brokerage firm Jones Lang LaSalle, said the worst of corporate downsizing is in the past and there is widespread albeit careful optimism. The overall office vacancy rate remains in double digits, favoring tenants, but employers generally continue to “right-size” their space requirements and limit new hiring.

“The challenge for occupiers is that many companies still don’t have the confidence to take out big long-term leases or grab extra space, since they are still contracting,” Fleck said. He noted that while full-floor office space availabilities are now few and far between in high-demand markets like University Towne Center, the slate of companies requiring that much space is also limited.

Still, firms in technology, health care and other sectors are filling spaces in existing buildings, as new construction remains scarce. Local brokerage firms reported that leasing activity in the latest quarter was led by Qualcomm Inc.’s deals for a total of more than 124,000 square feet in two Sorrento Mesa locations, bringing its new leasings for 2012 to approximately 500,000 square feet.

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Also during the quarter, the law firm Latham & Watkins LLP signed a deal for 70,000 square feet in Del Mar Heights; Legends Films Inc. did a 58,000-square-foot sublease in Carlsbad; and The Aspire Center, operated by the local division of the U.S. Department of Veterans Affairs, took 45,000 square feet in Old Town with plans to open a health care facility in 2013.

Brokerage firms noted that tenants scouting the local market for additional future office space include the city of San Diego, seeking 500,000 square feet; Qualcomm, eyeing another 100,000 square feet; Union Bank, looking for 85,000 square feet; ESET, seeking out 80,000 square feet; and technology-oriented firms Websense Inc. and Genoptix Inc., each scouting for 150,000 square feet.

Increase in Leasing Velocity

Voit Real Estate Services reported the San Diego region’s total vacancy rate stood at just over 14 percent at the end of September, down 4 percent from a year ago. Brokerage firm Cushman & Wakefield said the region’s direct vacancy rate, not including subleasable space, was 13.2 percent —down from 14.7 percent a year ago and the lowest rate among Southern California office markets.

“We’ve seen an increase in leasing velocity in the last 12 months,” said Chris High, associate director in Cushman & Wakefield’s San Diego office. However, there was a general slowdown during the third quarter, possibly as employers waited to see results of the fall political season before proceeding with moving and hiring plans.

Brandon Keith, senior vice president in Voit’s San Diego office, said although there is widespread caution about adding space, company leaders do have a sense that the market is tightening, rents are rising and competitive incentives among landlords are fading in several submarkets. That’s prompting some companies to move off the fence and lock in current rates.

“You’re seeing tenants going for four or five-year leases, on the belief that prices have bottomed out and they don’t want to be stuck three years from now trying to renew in a landlord’s market,” Keith said.

Well-capitalized property investors are still competing for trophy office acquisitions as purchase prices rise, although many remain on the sidelines awaiting a full-fledged recovery in office demand, which would lead to rising rents in more neighborhoods.

The latest quarter’s largest local purchase transactions included Irvine Co.’s $52 million acquisition of the Centerside I office tower in Mission Valley; the $51 million purchase of three Torrey Pines buildings by Walton Street Capital and Legacy Partners; and a 13-property, $40 million acquisition in Sorrento Valley by Parallel Capital and Angelo Gordon.

“I think you’re going to see more investment money coming off the sidelines as more people realize that the market has bottomed out,” Keith said.

While proposed federal defense cuts could have the effect of dampening demand for local office space in the long run, Keith said there is so far little evidence that the defense footprint is contracting. In some defense-related areas like aerial drone development, space demand has actually increased recently in Rancho Bernardo and other submarkets along Interstate 15.

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