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8/04/11
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While San Diego office market fundamentals may not be as strong as they were prior to the recession or as weak as they were during the recession, they are definitely improving. Statistics we became accustomed to before the recession (4Q07), such as an 11 to 13 percent countywide vacancy rate and a robust annual leasing activity ranging from a half to two million square feet, are unrealistic in this post-recession environment; however, the office market is making strides in the right direction.
Countywide total vacancy, including sublease space, was 19.6 percent in the second quarter of 2011 compared to 19.8 percent last quarter and 20.3 percent a year ago. The current vacancy of 19.6 percent is 4.1 percentage points higher than the 15.5 percent recorded at the start of the last recession (4Q07) but 2.1 percentage points lower than the peak rate of 21.7 percent recorded at the end of the recession (2Q09). Vacancy is expected to continue to tighten gradually throughout the year.
Demand for space, supported by a moderate overall economic growth, continues to slowly reduce vacancies in prime submarkets. Flight-to-quality and renewals within a 5,000 to 20,000-square-foot range are the main drivers of leasing activity, with Class A leading the way. In the second quarter of 2011, Class A recorded 326,250 square feet of positive net absorption countywide marking the eighth consecutive quarter of positive Class A absorption. Over the last two years through the second quarter of 2011, tenants have absorbed a total of 1.7 million square feet of Class A space countywide which translates into an average quarterly net absorption of 210,000 square feet. As a result of tenants taking advantage of favorable rates and concessions, the Class A direct vacancy rate countywide has decreased from 19.4 percent two years ago to 15.2 percent in the second quarter of 2011.
Conversely, Class B leasing activity has been in the red for six of the last eight quarters (since the end of the last recession in 2Q09), including the second quarter of 2011 when it returned 82,340 square feet to the market countywide. Over the last two years, tenants have returned an average of 86,000 square feet each quarter and the direct Class B vacancy rate has increased from 18.6 percent two years ago to 19.9 percent in the second quarter of 2011, which is the highest documented rate since the end of the 1990s.
Evaluating leasing activity by submarket, among submarkets that saw the greatest improvement, or more than a five percentage point decrease in direct vacancy from a year ago are Rancho Bernardo and East Chula Vista. Among submarkets that posted a one to five percentage point decrease in vacancy rate from a year ago are UTC, National City, Governor Park, Mission Valley, Escondido, Encinitas, Carlsbad, Sorrento Valley, Sorrento Mesa and Old Town. Among submarkets that are still struggling with high vacancy rates are Rose Canyon, Vista, Scripps, Poway and Downtown.
Forecast
Improvements in market fundamentals will continue to be more evident in the prime submarkets while other submarkets will remain in status quo throughout 2011 and beyond. As a result, overall office market performance will remain mixed as it will be well into 2012 before the recovery is felt in all submarkets across the county.
The pace of recovery depends on job growth. During the latest recession, San Diego lost 84,100 jobs in which 31,400 were office jobs. Since the end of the recession, San Diego has added 8,200 jobs in the professional and business services sector but lost an additional 4,900 office jobs in the financial and insurance sectors. The good news is that the total employment in San Diego has been growing, albeit slowly, for the last 11 months as measured by a 12-month percentage change and is forecasted to grow 1.8 percent in 2011 and 2.3 percent in 2012. The countywide unemployment rate of 9.6 percent as of May 2011 has decreased 1.3 percentage points from the peak rate of 10.9 percent recorded in July 2010 and is forecasted to decrease to 9.4 percent in 2012. In the near-term, expect to see more of the same, slow but steady employment growth building on previous monthly gains resulting in slow and steady quarterly improvements in leasing activity.
A lack of new construction countywide will help support the slow leasing recovery by helping to continue to boost Class A rental rates as tenant demand strengthens countywide. As Class A supply tightens, demand for Class B space will increase. Tenants currently in the market are looking for more than two million square feet over the next 24 months. While not all of these tenants will transact, leasing activity will strengthen moderately through 2011.
Although rents have stabilized over the last four quarters, major increases are not expected in 2011. Average Class A asking rents have remained at $2.61 per month full service for four consecutive quarters, while tenant demand for space in other classes remains spotty and not enough to support rent increases.
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