Trends like the comeback of San Diego’s downtown urban core, along with rising space demand fueled by the booming craft beer industry, contributed to continuing improvement in the region’s office and industrial real estate markets in the first half of 2014.
Local commercial brokers note that employment gains in sectors like technology and professional and business services are bringing increases in office rents and leasing activity, along with drops in vacancy rates for most neighborhoods. The pace of improvement, however, is muted by the trend of companies continuing to do more while using less office space in their daily operations, aided in part by mobile technology.
Brokerage company JLL reported San Diego County’s total office vacancy rate at 15 percent at the end of the second quarter, up slightly from a year ago but projected to head downward for the next 12 months. Rents rose from the prior quarter — to an average $2.28 per square foot — marking the sixth consecutive quarter of rent increases countywide.
At the same time, JLL pointed to conflicting signals in the market. While the second quarter saw a 16 percent increase in leasing from the prior quarter, with deals completed totaling about 1.3 million square feet, the activity was down from second quarter 2013.
As usual, some office neighborhoods are hotter than others when it comes to demand, meaning that some are more tenant-friendly when it comes to rents and availabilities. With the recovery steady but flattening, local JLL Executive Vice President Randall Wood said, tenants are still finding a variety of well-priced sites in places like Carlsbad and downtown San Diego.
While the downtown office vacancy rate remains above the county average — 16.5 percent as of the second quarter, JLL reported — landlords are renovating buildings to attract a growing contingent of young workers who prefer to live and work in vibrant urban centers.
The trend was illustrated by recent downtown move-ins by two large companies previously headquartered in more suburbanlike office campuses: Bumble Bee Foods LLC and Kleinfelder Inc.
Wood said younger workers want more options for dining and socializing during the workday, and that they are more likely to make numerous trips to and from the office throughout the day, often well past 5 p.m.
“The boundaries between work life and life outside work are really blurring in places like downtown,” Wood said.
Still Room to Bargain
Brokers point to several landlord-centric neighborhoods where office vacancies remain low, prices are rising, and options for companies seeking large contiguous blocks of space are dwindling. Those include Del Mar Heights, University Towne Center, Mission Valley, Sorrento Mesa and Sorrento Valley.
But there is still bargaining room for tenants seeking smaller spaces, especially in older Class B properties now seeing a wave of renovations to keep them
competitive. However, even those are being snapped up in the high-demand markets, as the county continues to see almost no new office construction.
“You have to look at it on a submarket-by-submarket basis,” said John Jarvis, senior vice president at San Diego-based Hughes Marino Inc., which primarily represents tenants. “There are buildings in nearly every neighborhood where a tenant can find deals.”
In some cases, for instance, a building may be owned by a publicly traded real estate investment trust that is eager to keep its properties filled and may be amenable to price breaks or other incentives.
Overall, the competitive nature of the local market — with landlords investing extensively in upgrades — has substantially boosted the overall quality of the region’s available office supply.
“The newer spaces available here are probably at the highest level of quality that we’ve seen in a while,” Jarvis said.
Technology, Biotech Drive Demand
While the overall pace of the local economic recovery appears to be flattening out, certain sectors are contributing more than others to rising office demand. Ryan Egli, first vice president in the San Diego office of CBRE Group Inc., cited still-tight space availability relative to local demand in industries such as software development, wireless telecommunications and biotechnology.
That is to the advantage of building owners in markets like Sorrento Valley, Sorrento Mesa, Kearny Mesa and UTC. Irvine Co. is building a new speculative tower at UTC, and other landlords are generally bullish about their prospects of filling current spaces and even considering new developments at UTC and other high-demand areas, like Del Mar Heights.
“The pendulum is definitely moving in favor of the landlords,” Egli said of those popular markets, which command higher rents.
More Industrial Users Seek to Buy
In the region’s industrial sector, local brokers note that a rising of number of company owners are looking to own rather than lease their buildings, in part to lock in still-low financing rates and cut future long-term overhead.
However, the number of current owners looking to sell has been dwindling as overall economic fundamentals have improved. There is little new construction underway and not much land available to build new product, so properties that sell are commanding higher prices.
“If it’s a product that’s worth buying, it’s got a lot of offers on it,” said Todd Davis, senior vice president in the San Diego office of Cassidy Turley.
Davis said there is a generally high level of confidence among industrial tenants about their future prospects, which is encouraging them to seek space for current and future expansions. That trend extends to companies tied to the building materials and construction industry, including those that deal with heating-and-cooling systems and roofing supplies, as well as craft beer and other types of manufacturers.
Brokerage company Colliers International reported that San Diego County’s overall industrial vacancy rate was 8 percent at the end of the second quarter, marking the seventh consecutive quarter in which local vacancy remained below 10 percent.
Greg Kelly, a vice president in Colliers’ San Diego office, said current hot markets for industrial demand include Miramar, Kearny Mesa and Poway. Demand growth in those neighborhoods continues to be stoked by growing industries preferring close freeway access, such as craft beer, aerospace, construction and other firms involved in light manufacturing.
North County More Active than South
While central San Diego, North County and South County have all recently seen improvements in leasing activity, South County continues to lag the other regions for overall deal-making, partly a reflection of geography-related necessities for many local firms that serve customers to the north.
South County has an opportunity to benefit long term from recent road and other border-area infrastructure improvements as the overall cross-border economy improves, although the manufacturing economy is still lagging south of the border.
“You’re going to need to see more recovery on the Mexico side,” Kelly said.
Brokers agreed that North County has generally been the biggest regional beneficiary as industrial markets have tightened in Central San Diego.
Ron King, senior director in the Carlsbad office of Cushman & Wakefield Inc., noted that North County has 10 to 15 companies scouting for industrial spaces of 50,000 square feet or more, and most if not all of those requirements will likely be fulfilled before the year is out.
Many of the companies filling those North County spaces will be craft beer brewers and other manufacturers unable to find suitable expansion and set-up spaces in crowded markets like Miramar and Kearny Mesa.
“Eventually as those spaces get filled up, that’s going to drive the leasing rates up,” King said.