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Things May Be Looking Up as Office Market Is on the Bottom

San Diego is by no means alone in having an office market that remains in the “bottoming” phase of its real estate cycle.

In fact, the latest National Office Occupier Outlook report, by the brokerage firm Jones Lang LaSalle, categorizes nearly every major U.S. market in that mode.

There are no markets listed as “peaking” or “falling,” and only three are considered to be “rising” — San Francisco, Pittsburgh and Washington, D.C. Meanwhile, Baltimore and Denver are on the borderline between a bottoming and rising market.

The largest group of office markets, including San Diego, is no longer in free fall but hasn’t yet left the bottom, because of a combination of excess supply, high vacancies and limited employment growth that is dampening office space demand.

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San Diego sits near the middle of the pack, at about the same stage of its office real estate cycle as markets including Chicago, Los Angeles, Silicon Valley, Charlotte, N.C., and Fort Lauderdale, Fla.

But the national situation is steadily changing as the economy improves. The brokerage firm notes that while 94 percent of U.S. markets are now “tenant favorable,” that figure will be just 31 percent in 2012.

In San Diego, the firm says asking rents dropped 7.3 percent during the past year, largely due to the “flight to quality” trend of companies relocating to better sites thanks to competitive incentives. Rents in various submarkets are down 10 percent to 25 percent from pre-recession highs, with some vacancy rates still above 20 percent.

However, while there is some light mixed-use and build-to-suit activity, the development pipeline for speculative office buildings is empty, and 2011 could be the first year in decades with no new spec office development.

That means tenants’ window of opportunity is gradually closing, as some industry sectors see employment growth and the best locations get snapped up. Jones Lang LaSalle says tenants in a position to renew in the next year are encouraged to do so before the market begins a more robust recovery and rents head upward.

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Tracking the Big Downtown Markets: Jones Lang LaSalle also recently released its inaugural “Skyline 20” report, comparing the downtown office markets of 20 large U.S. and Canadian cities. And it appears that San Diego’s performance — based on what was happening with its 20 biggest downtown high-rises at the end of 2010 — has a lot of room for improvement.

San Diego’s downtown total vacancy rate of 17.6 percent places it 15th among the major markets. (New York City’s vacancy was lowest at 10.5 percent.) San Diego’s 2010 net absorption, at negative 51,979 square feet, placed it 16th. (Charlotte was first with a positive 1.2 million square feet.)

The average asking rent of $27.96 per square foot placed San Diego at 17th. (Washington, D.C., was first at $70.64.) The 12-month rent change of negative 8 percent placed it at 18th. (No. 1 San Francisco saw a 6 percent rise.)

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Capital Firm Backs La Jolla Project: Since its founding in 2009, San Diego-based Presidio Residential Capital has wasted little time putting its cash to work. The privately held company, led by founder and Chief Executive Officer Don Faye, has financed 10 projects throughout California in the past 14 months, exceeding $120 million.

The latest is a 24-home development in the heart of La Jolla. Presidio announced March 3 that it made a $10.5 million loan to Zephyr La Jolla Investors LLC, which plans to build 24 townhomes on Pearl Street at Herschel Avenue.

The low-rise luxury town houses, called La Jolla Townhomes, will replace an existing six-unit apartment complex and a single-story commercial office building.

The loan to Zephyr will help fund the land purchase, demolition and construction at the site, which covers about a third of an acre. Zephyr bought the parcel from Pearl & Herschel LLC for $7.6 million, according to brokerage firm Lee & Associates, which represented the buyer.

Zephyr is looking to break ground in the next three to four months.

Send commercial real estate and development news of general local interest to Lou Hirsh via e-mail at lhirsh@sdbj.com. He can be reached at 858-277-8904.

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