Friday, April 4, 2008

San Diego commercial vacancy rate skyrockets

Construction, housing bust, slowing economy blamed

Voltron says: more good news for SRS

San Diego's office vacancy rate spiked to its highest level since 1996 in the first quarter thanks to a combination of weak demand and new buildings coming to market.

Direct vacancy – landlord-controlled office space that's empty – was 15.1 percent countywide, according to a CB Richard Ellis report issued yesterday. That's up from 11.5 percent a year earlier.

The availability rate, which includes sublease space, buildings under construction and offices on the market but not yet vacant, came in at 21.3 percent for the quarter. Last year, availability was 18.2 percent.

Brokers say new construction is a big contributor to the spike – particularly in business districts with much speculative office building, such as Rancho Bernardo and Carlsbad.

But they also point to a slowing economy and the fallout from the housing bust as contributing to the vacancy boost. Many mortgage companies, title firms and home builders have closed or downsized over the past year.

Net absorption – a real estate term that measures the amount of space leased versus the amount vacated – was negative 190,000 square feet for the quarter. The three-year quarterly average is positive 224,000 square feet, according to CB Richard Ellis.

“The residential real estate industry ripple effect is a blood bath,” said David Marino of Irving Hughes, which specializes in representing tenants. “When we got hit hard in 2001 through 2003 in the tech side, the residential real estate guys took a lot of that space. Today, there's no recovering industry sector to offset” the decline from housing-related companies.

Not all brokers take such a harsh view. They point out that the amount of space shed by residential real estate companies isn't close to the avalanche of offices that technology companies abandoned during the dot-com implosion.

“This is not like the 'dot-bomb' era where you saw all these companies closing up,” said Brian Driscoll of Grubb & Ellis/BRE Commercial.

Although residential real estate firms are letting space go, technology, biotech and other nonresidential companies are holding steady, Driscoll said. “We have a much more diverse and seasoned tenant base than we did 10 or 15 years ago,” he said.

Office demand is directly linked to job growth. The county is projected to create 6,400 jobs in 2008, according to CB Richard Ellis. That's down from 9,200 jobs in 2007 and 14,000 jobs in 2006.

The slumping demand comes after a wave of office construction over the past couple of years. Carlsbad and Rancho Bernardo have been particularly hard hit. The direct vacancy rate for office buildings in both business districts eclipsed 20 percent for the quarter.

In business districts where there has been less construction and demand remains relatively healthy, such as Carmel Valley and University City, vacancies haven't spiked as severely, brokers said. In Carmel Valley, vacancy was 7.5 percent, while in University City it stood at 10.9 percent.

“Well-located landlords will continue to do well in spite of the current conditions, whereas landlords with properties in secondary markets will have to structure creative deals to stay competitive,” said Jeb Bakke, a senior vice president with CB Richard Ellis.

Marino, the Irving Hughes broker, said landlords have been adopting this theme, which he calls NIMS: not in my submarket. “Everybody has problems but me,” Marino said. “That's nonsense. This market is being affected in every way by this recession and this residential real estate collapse.”

Scot Ginsburg, a principal with broker The Staubach Co., said landlords are offering concessions to lure tenants. But so far, they're not lowering rents.

“The one consistent thing I see around town, no matter how eager the landlord is to lease the space, is they're not dropping their (asking) rents,” he said. “What they're doing is buying it down with free rent.”

Ginsburg noted that some landlords are offering free rent for six months or longer to get deals signed. “The newly constructed buildings are getting very aggressive, especially in Carlsbad,” he said.

Tom van Betten, a broker with Cushman & Wakefield who focuses on the Interstate 15 corridor, said it could take some time for current space to lease up, particularly with all the new construction.

But the news isn't all bad, he said. Sony Electronics has committed to the area by starting construction on a $150 million campus in Rancho Bernardo, and Bridgepoint Education agreed to lease 289,750 square feet in the three-building Kilroy Sabre Springs campus during the quarter.

“Rancho Bernardo has a lot of big chunks of space that are really set up for corporate headquarters-type projects,” van Betten said. “We're just all kind of holding our breath that the existing darlings in the market – the Sonys and General Atomics and Northrop Grummans – continue to grow organically, or somebody comes in from outside the area.”

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