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San Diego Office Market Rebounding from Pandemic Impact

10/20/21

This report was provided by real estate services firm Cushman & Wakefield

ECONOMIC OVERVIEW: Employment Fundamentals Rebounding

The San Diego employment market has recovered more than half (57%) of the 248,000 jobs lost during the beginning of the pandemic, between March and April of 2020. Nonfarm employment grew by 59,200 or +4.4% year-over-year (YOY) between August 2020 through August 2021, with the leisure and hospitality sector accounting for 31,000 jobs added (+23.2% YOY). During the same time, the monthly unemployment rate decreased from 10.8% last year to 6.6%. The current monthly rate is 930 basis points (bps) lower compared to the 15.9% high recorded in April of 2020 and 20 bps above the Q3 2021 quarterly average of 6.4%.1

All employment sectors are expected to grow at a combined rate of 2.0% in 2021 and 4.5% in 2022. Office employment is forecasted to grow 1.8% in 2021 and 2.7% in 2022. San Diego’s economy of $241.7 bil as measured by 2020 gross regional product is forecasted to return to growth of 7.9% in 2021 and 5.1% in 2022, above its 10-year average of 2.7%.2

SUPPLY AND DEMAND: Life Sciences Drive Positive Growth

At the end of Q3 2021, San Diego’s direct office vacancy was 13.9%, a decrease of 10 bps from the previous quarter and an increase of 60 bps from a year ago. Tenants absorbed 264.6k sf in Q3 2021, marking the third consecutive quarter of occupancy gains since the beginning of the COVID-19 pandemic and bringing year-to-date occupancy gains to 808.2k sf. Class B buildings absorbed the most space in Q3 2021 (+190.9k sf), followed by class A product (55k sf) as employers seek to incentivize their employees to return to the office via high-end, amenitized office space.

Sorrento Mesa recorded the most positive absorption in Q3 2021 (+134.7k sf), followed by Del Mar Heights (+105k sf) and Torrey Pines (+92.9k sf). Large life sciences tenants likeAltos Labs, Quantum-Si and ViaCytewere the primary drivers of absorption, occupying Genesis Morehouse in Sorrento Mesa. Three submarkets -UTC (-75.4k sf), Downtown (-62.5k sf) and Rancho Bernardo (-43.2k sf) -recorded the most negative absorption in Q3 2021, primarily driven by mid-sized tenants vacating or downsizing.

TENANT TRENDS: Demand Remains Strong in Mid-Cities

Leasing activity trended upward in Q3 2021 at 1.6 msf across 95 deals, excluding renewals, compared to 1.3 msf (112 deals) in Q2 2021 and 919.6k (100 deals) in Q3 2020. Sorrento Mesa (23%), Del Mar Heights (19%) and UTC (14%) accounted for 56% or 930.2k sf of new deals leased in Q3 2021. Tandem Diabetes signed a 182k sf lease at Del Mar Corporate Centre for the largest deal signed this quarter, neighboring a 96k sf lease by DermTechat the same project.

In Sorrento Mesa, Sorrento Therapeutics committed to a 163k sf build-to-suit project, while also extending four leases at other projects with the same landlord. Apple also continues to grow in the region, leasing 140k sf at La Jolla Reserve in UTC in addition to expanding their footprint in UTC, Eastgate and Rancho Bernardo. Most of the expected future absorption from previously signed leases will come from the life sciences sector, including tenants like Shoreline Biosciences, Biolinq and TriLink Biotechnologies. Though activity from traditional office tenants has largely been limited to renewals, Apple has nearly 350k sf of leases that are expected to occupy over the next 12 months across existing and under construction projects, with further plans for a major San Diego campus.

PRICING: Class A Rents on the Rise

Countywide asking rent across all classes remained unchanged from the previous quarter at $3.43/sf on a monthly full-service basis but increased $0.04 (+1.2% YOY) from a year ago. Over the past 12 months, Class A average rent has increased by 5.0% to $3.9/sf, while the Class B rent has decreased by 6.6% to $3.11/sf. New speculative (SPEC) construction and life sciences conversions of older buildings are expected to push rents higher over the next twelve months.

FUTURE INVENTORY: Life Sciences Radius Expanding

Of the 19 properties totaling nearly 3.3 msf currently under construction countywide, 31.3% are pre-leased and 695k sf (10 buildings) are expected to be delivered by the end of 2021. The majority, or 89%, of inventory is spec with the remaining 11% build-to-suit. Landlords continue to be aggressive with spec development, as plans move forward for American Assets Trust on the third building at La Jolla Commons in UTC.

Over 53% or 1.8 msf of inventory currently under construction is located inthe Downtown submarket. In addition, Kilroy Realty Corporation announced the acquisition of land across the street from their existing project in Little Italy. As of Q3 2021, Torrey Pines vacancy dipped to 3.4%, requiring tenants and landlords to seek opportunities outside of the traditional life science nucleus. Though biotech landlords continue to acquire projects in Sorrento Valley and Sorrento Mesa for life sciences conversion or redevelopment, they are also looking elsewhere.

In Q3 2021, Alexandria acquired the creative office Make and the multi-tenant industrial Commerce projects in Carlsbad. In Del Mar Heights, Phase 3 Real Estate purchased Champs Plaza. In Scripps, Alexandria plans to build a new lab project at the Scripps Corporate Plaza site. These notable transactions coupled with diminishing supply in the core life sciences submarkets are causing life sciences tenants to expand to new frontiers. Current demand will outpace new supply coming online in the next 24 months in the mid-cities, forcing life sciences users to expand their search parameters and continue this trend.

Sources:1 - www.bls.gov 2 - GDP as of 2020. Moody’s Analytics economy.com 9/22/2021.

OUTLOOK

•Expanding COVID-19 vaccine eligibility in California and throughout the country will result in increased activity through the year; however, tenants are reassessing their real estate footprint based on work-from-home policies as well as assessing both short and long-term needs working through and after the pandemic. Leasing within the 10k sf to 50k sf range will continue to be the main driver of activity, accounting for 59% of total sf in lease obligations set to expire over the next 18 months.

•Active tenant requirements of all sizes remain robust at 5.9 msf over the next 24 months countywide, led by Apple’s search for a San Diego campus. While many of these tenants paused their plans due to COVID-19, a majority have reactivated their requirement or begun exploring the market. While not all current tenants in the market will transact in the short term, these levels provide a barometer to leasing activity in subsequent quarters.


This report was prepared by:

JUSTIN BALAGTAS
Senior Research Analyst
Cushman & Wakefield

JOLANTA CAMPION
Senior Director of Research
Cushman & Wakefield




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