San Diego’s office market kicked off 2018 on stable footing as vacancy continued to decline while occupancy showed further improvement, according to a Q1 report from Cushman & Wakefield (C&W). Countywide vacancy shed another 40 basis points (bps) since year-end 2017 to close the first quarter of 2018 at 12.9 percent, its first appearance below 13 percent since the third quarter of 2006.
Meanwhile, occupancy finished with a moderate 65,000 square feet of positive net absorption.
“After achieving 1 million square feet of occupancy growth in the latter half of 2017, fueled by a remarkable third quarter, San Diego’s office sector throttled a bit during the opening months of 2018, but still maintained its positive momentum — representing its 15th consecutive quarter of occupancy gains,” says Jolanta Campion, C&W’s research director in San Diego. “With the exception of 2017’s robust 456,000 square feet of positive net absorption, in recent years the first quarter of each year has tended to start off slower but are not always a precursor to the year’s occupancy performance — in fact, from 2012 through 2016, the first quarter averaged only about 110,000 square feet of growth, but their five-year annualized average was still over 1.2 million square feet.”
Campion adds that the majority of the Q1 gains in the class-A sector (+126,244 square feet) were negated by tenants returning nearly the same amount of class-B space (-125,842 square feet). Class-A overall vacancy stood at 14.4 percent countywide, down 30 bps from last quarter and down 120 bps from a year ago. Class-B overall vacancy was 12.3 percent, down 60 bps from last quarter and 250 bps from a year ago.”
According to Brett Ward, managing director of C&W’s office division in San Diego, “Although absorption in the first quarter was modest, there were still a few notable mid-sized occupancies. The most significant was WeWork moving into its second San Diego location at the Aventine in UTC, totaling 52,000 square feet. Another co-working provider, Avanti Workspace, expanded by 25,000 square feet at its location in Carlsbad. Co-working is gaining popularity among tech startups and creatives such as marketing and web-design companies, along with freelancers and independent contractors from the FIRE employment sector. Physical and financial flexibility are becoming the new ‘normal’ for the 21st-century workforce, and co-working supports these needs. Meanwhile, in Sorrento Mesa, iMatrix moved into 25,000 square feet at a creative-office building in the Morehouse Tech Center.”
Ward adds that throughout the rest of the year, a number of large tenants are still expected to occupy pre-leased space and/or new developments that should bolster absorption in future quarters in addition to any new leases transpiring. “We still anticipate, barring any geopolitical or other catastrophic or unexpected events, 2018 should be another very strong year for San Diego’s office sector.”
The report also indicated that overall average asking rents for all office spaces across San Diego continue to rise, just surpassing the $3-per-square foot mark to $3.02 per square foot per month on a full-service basis. This marked the first time the average rate has moved above the $3-per-square-foot mark since the firm began tracking data for this market in 2003. Average rents surged another $0.24, or 9 percent year-over-year, up from $2.78. Notably, this is also a similar level above its peak level of the prior cycle ($2.77 in Q1 2008), particularly due to the amplitude of both class-A as well as class-B rents. Class-A asking rents closed the first quarter of 2018 at an average of $3.42 per square foot. Comparatively, class-B was $2.80, whereas class-C space came in at $1.95. Class-A asking rents are up $0.22 or 7 percent from a year ago, while class-B and -C were up 9 percent and 6 percent, respectively, for the same annual period.
Campion says, “Both class-A and class-B average asking rates have reached record highs, while class-C is virtually on par with its peak level.”
According to the report, there are currently 20 properties totaling 1.9 million square feet currently under construction countywide, 17 of which, totaling 1.6 million square feet, are scheduled for completion in 2018. Just over 798,000 square feet or 43 percent of the inventory under construction are part of build-to-suit projects.
Derek Hulse, managing director of C&W’s San Diego office division, says, “New construction remains a vital component to San Diego’s real estate landscape. ViaSat, which is headquartered in Carlsbad and employs nearly 2,000 workers, is expanding its footprint. The company’s Bressi Ranch site in Carlsbad is planned for three phases, which will total approximately 792,000 square feet at build out, with 280,000 square feet scheduled to be completed in 2018. In Eastgate, Takeda Pharmaceuticals has a build-to-suit lease for over 163,000 square feet, and in Rancho Bernardo Palomar College is scheduled to complete its 110,000-square-foot build-to-suit. Additionally, MedImpact will occupy the first of three buildings at the Watermark in Scripps for 159,000 square feet, and UCSD has two projects currently under construction, a 57,000-square-foot in Rancho Bernardo and a 53,000-square-foot at Park + Market Downtown. All of these will add to our absorption figures upon occupancy.”
Hulse adds that the San Diego employment market continues to record job growth, adding 27,900 jobs (+1.9 percent) year-over-year through February 2018, with the unemployment rate falling 90 basis bps to 3.5 percent during the same time period, according to California EDD. “The latest reporting month of February 2018 alone gained another 11,500 jobs, reflecting continued regional momentum. Of the 27,900 jobs added y-o-y, 9,400 (or 34 percent) were office jobs consisting of two sectors: professional and business services and financial activities. Notably, between 2016 and 2017 San Diego gained approximately 2,150 jobs specific to the tech sector, according to Cyberstates.org. Looking ahead, office employment is expected to maintain stable growth levels, with tech also expected to be a considerable source of demand for local job opportunities.
Meanwhile, Hulse says, office demand among San Diego companies remains robust with 3.3 million square feet potentially transacting over the next few years. “Continued economic growth and resulting job growth, in combination with increasing tenant demand, should provide for continued occupancy and rent growth throughout 2018 and into 2019.”