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8/18/11
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The following 2nd quarter summary and report for the office market in San Diego County has been provided by Grubb & Ellis.
HIGHLIGHTS
• The San Diego area office market vacancy rate fell to 17.4 percent during the second quarter, down 30 basis points from the first quarter.
• Vacancy in the CBD increased to 18.5 percent, up 80 basis points from a quarter prior.
• The office market experienced 340,176 square feet of positive net absorption during the second quarter, bringing the year-to-date absorption total to 492,355 square feet.
• Class A properties accounted for the majority of the positive net absorption, posting 286,008 square feet during the quarter. Class B and C properties witnessed 38,521 and 15,647 square feet, respectively.
• Carlsbad led in positive net absorption; with tenants taking occupancy of a net 183,860 square feet during the second quarter.
• Quarter-to-quarter, monthly asking rental rates for Class A space remained unchanged at $2.53 per square foot, while average asking rental rates for Class B space increased $0.02 to $1.98 per square foot.
• Approximately 1.4 million square feet of sublease space was available at the close of the second quarter, a 171,000-square-foot decrease from the first quarter.
Mid-Sized Tenants Expand, Class A Properties Slowly Recover
Moderate but steady employment growth fueled positive absorption for the fifth consecutive quarter in the San Diego office market. Between May 2010 and May 2011 the region added 6,300 jobs in the professional and business services sector - a key contributor to office occupancy. The second quarter closed with 340,176 square feet of positive net absorption, the highest figure since the close of the third quarter of 2009. This is especially impressive in a down economy given a lack of large tenants in the market.
The second quarter’s largest new occupant was UCSD Extension committing to 49,109 square feet at 6256 Greenwich Drive in Governor Park while the largest lease execution saw AutoAnything lease 40,431 square feet at 6602 Convoy Court in Kearny Mesa. In 2010, five leases ranging from 57,000 square feet and 196,734 square feet had been executed by mid-year compared to zero in 2011. Nonetheless, with positive absorption currently outpacing 2010’s move-outs and market-wide vacancy down 30 basis points since the first quarter, it is evident that small to mid-sized tenants carried the office market during the second quarter. These companies have adapted to the rigid business environment and are commencing in expansion activities-albeit at a considerably slower pace compared to the early and mid 2000’s.
The dominant owner of Class A office properties in San Diego, The Irvine Company, has seen a gradual increase in occupancy among its top assets. During the recent recession the Southern California based company decreased rental rates across its assets and is now finally reaping the benefits through a reduced vacancy rate in San Diego; estimated to have dropped 340 basis points since June 2010 to 19 percent. The decrease in supply will increase rental rates in local Irvine Company dominated submarkets which will cause a domino effect on all local Class A assets and eventually spread to B and C assets. The migration of tenants from Class B and C properties to A properties, also known as “flight to quality”, will gradually fade as empty office spaces are absorbed in high-end buildings.
The second quarter’s 286,008 square feet of positive net absorption in Class A assets is indicative the market is slowly gaining momentum as top tier office properties lead a longwinded recovery.
FORECAST
Class A office properties will lead a slow recovery through improved occupancy thus justifying an eventual increase in rental rates.
New speculative construction will require significant tenant commitments in order to be built. New development will not be a factor in shaping market fundamentals in the foreseeable future.
Conditions will remain advantageous for tenants however land lord concessions have peaked and lease rates have compressed to their absolute minimum.
ANALYSIS
The San Diego area office market experienced moderate but steady employment growth over the past year, adding 6,300 professional and business services jobs during the 12-month period ending May 2011. This growth contributed to the positive net absorption experienced during the second quarter, which was carried out by small to mid-sized tenants. These companies have adapted to the rigid business environment and are beginning to expand. The largest lease to take place during the second quarter was AutoAnything’s lease of 40,431 square feet of space. Class A office properties are expected to lead the market in a slow recovery through improved occupancy and in turn, an eventual increase in rental rates. New developments are not expected in the foreseeable future without significant tenant commitments prior to breaking ground. Tenants will continue to have access to lease concessions, but these packages have peaked and lease rates have likely hit bottom.
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