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San Diego Office Market Caps Off 2018 with Flat Q4 Absorption

2019 Outlook Still Remains Strong

Market Reports 500,000 SF Annual Net Growth in 2018 while Deal Flow Stays Solid

San Diego CA— San Diego’s office market ended 2018 on a bit of a flat note, with vacancy rising moderately in the fourth quarter coupled with slender occupancy loss, according to Cushman & Wakefield’s year-end market report. Overall, office vacancy rose to 13.8% in the fourth quarter, up a modest 40 basis points (bps) from the previous quarter, and placing it 50 bps above 2017. Despite the second half of the year experiencing an uptick in vacancy due primarily to new product deliveries, San Diego still recorded nearly one half million square feet of net office growth in 2018. And the firm maintains a positive outlook forward.

Jolanta Campion, Cushman & Wakefield’s Research Director in San Diego, said “The office market returned a modest 96,300 square feet of space to cap off the year, putting annual direct net absorption at a still positive 489,300 square feet for 2018. And while the loss was not severe, it did put an end to what had been a steady streak of growth during 2018. It also put an end to a remarkable regional streak of 17 consecutive quarters of solid occupancy gains during which tenants absorbed 6.5 million square feet (msf) combined across all classes.”

According to the report, you have to go back four and a half years (Q2 2014) to uncover the last red growth quarter—to which the market went on to rally thereafter, recording significant growth until Q4 2018. Experts also point to the fact the quarter is likely just an isolated case, or blip, simply due to misaligned deal activity.

Campion stressed, “You must keep in mind net absorption compares move-outs with move-ins, which have primarily been negotiated long ago. San Diego’s current office gross leasing activity, which measures signed deals, remains robust—and across all key industries—and is comparable to recent robust years. Deals signed in 2018 will look to help drive overall growth in 2019 when they are officially occupied.”

The report also showed that 2018’s near 500,000 sf of net occupancy growth did pale in comparison to prior years 2014 through 2017 as well as 2012, all surpassing 1.2 msf of annual net growth. 2018 also marked the lowest amount of office growth since the Great Recession (2009). Nonetheless, this year’s tempered tally is not yet concerning Cushman & Wakefield’s experts, who believe positive growth trends should resume.

Brett Ward, LEED AP, Managing Director of Cushman & Wakefield’s San Diego Office Division, said “In the beginning of 2018, we expected stronger growth, given the robust amount of preleasing and ongoing demand leading up to and throughout the year. However, some of that expected activity has since rolled into 2019—which exact timing can be difficult to pinpoint especially given the amount of new product factored into the equation. Therefore, we continue to have a favorable outlook moving forward, as our tenant tracking demand still remains solid with 3.2 msf and our region continues to see good economic and job growth.

“Furthermore, the fourth quarter also saw signs of continued vitality in that while some significant office space was returned to the market, there were still a number of notable occupancies to end the year, led by a few build-to-suit projects—the largest being Takeda Pharmaceuticals moving into their new 164,000 sf building in Eastgate, while other notable move-ins came from leases signed earlier in the year or prior.”

He added, “Looking into 2019, the market will also see multiple significant vacancies absorbed from leases signed in 2018. In particular, Sorrento Mesa stands to benefit from significant absorption from Nuvasive—107,000 sf expansion, Dexcom—84,000 sf, Brain Corporation—59,000 sf; Curology—54,000 sf; and Cue—21,000 sf. Furthermore, in Mission Valley, Amp&rsand will get its first tenants with Encore Capital moving into 96,000 sf and Qdoba moving into 34,000 sf at the renovated project. In Rancho Bernardo, Daylight solutions will occupy 68,000 sf. At the Terraces in Kearny Mesa, Guild Mortgage continues to expand, claiming the remaining 66,000 sf in the project. In Downtown, coworking provider Spaces will open new locations on the west and eastern ends of Downtown, with 45,000 sf at the revamped and newly branded Kettner & Ash project as well as 30,000 sf in Makers Quarter.”

As indicated by several recent notable occupancies, new construction (along with renovated projects) remains a key focus in the changing landscape and success of the San Diego office sector, both historically and forward. As it stands right now, the region’s 1.7 msf of new product currently under construction are evenly split, with Build-to-Suits (BTS) consuming 53% of the total, and Speculative the remainder.

Brian Starck, Managing Director with Cushman & Wakefield’s San Diego office, said, “We are currently tracking 13 properties totaling 1.7 msf currently under construction countywide, all scheduled for completion in 2019. Just over 914,000 sf or 53% of this new inventory are part of build-to-suit projects that are preleased. Speculative projects comprise the remaining 47%, and include redevelopment projects such as Tower 180, 777 Front and Kettner & Ash all in downtown, as well as brand new development Lift in Carlsbad, a new ground-up creative project, to name a select few properties. While we anticipate continued pre-leasing activity, the level of new spec development is likely to continue to result in modest short-term upticks in vacancy as these projects come online.”

He added, “Notably, other future inventory includes the 285,000-sf One Paseo project in Del Mar Heights, which is already over 40% pre-leased, including 67,000 sf to ACADIA Pharmaceuticals.”

Cushman & Wakefield’s fourth quarter 2018 report also revealed the average asking rent for all classes has increased further to $3.08 per square foot (psf) on a monthly full service basis. This metric increased by five cents over the last three months, and is up 4.1% from the end of 2017. The increase is primarily due to the addition of large class A supply. Over the past 12 months, Class A average rent has increased by 6.3% to $3.53 psf while the Class B rate has increased by 1.1% to $2.87 psf.

Dan Broderick, Cushman & Wakefield’s Regional Managing Principal for the Southwest & Mexico, said “The most critical element impacting San Diego’s commercial market success is, of course, diverse job growth, which our region continues to add jobs at a strong level. According to the Bureau of Labor Statistics, San Diego added another 26,400 jobs (+1.8%) year-over-year through November 2018. Of these total jobs added, 16,500 (or 63%) stemmed from the professional and business services sector, a primary segment driving demand for office space. We are boasting an unemployment rate of 3.2%, below California and National numbers. As such, continued economic and job growth in combination with increasing tenant demand should provide continued occupancy and rent growth throughout 2019 and into 2020.”

FOOTNOTE: At a recent Investor event held by Cushman & Wakefield in San Diego, even more positive sentiment was expressed by the firm with regard to the local climate and outlook for San Diego’s commercial real estate and economic segments, with key highlights including:

  • San Diego is a bit of a late bloomer in the current market cycle, leaving more runway. Given its slow start in recovery, it has more upside than most other markets.
  • San Diego’s office leasing fundamentals remain strong
  • San Diego is an ideal market for office development, given the long-term absorption trend and age of inventory, and may even be underbuilt.
  • Just 15 years ago, San Diego actually recorded higher office rents than San Francisco, whereas today its average stands at about half of San Francisco’s.
  • While San Diego real estate has gotten pricey from a purchase standpoint, spreads still remain justifiable—and even has a nice buffer against rising interest rates. Further, San Diego office is not expensive relative to global cities. From a risk-adjusted basis, San Diego is a strong buy.

 

CLICK HERE to access Q4 2018 San Diego Office MarketBeat Q4 2018 Report Summary

CLICK HERE to access Q4 2018 San Diego Office Market Snapshot Stats by Submarket