Uptick in Leased Space Reverses Recent Trends, Expectations Remain Muted

Stubbornly high unemployment rates will keep expectations muted for San Diego’s office market in 2010. Experts say a still repressed demand for space means a continued market in favor of tenants, perhaps through mid-2011, as vacancies trend up and landlords offer competitive rent discounts and other perks to fill those spaces.

Newly released, first-quarter reports by several prominent commercial brokerage firms indicate the San Diego County office market is generally better off than a year ago, but it could be another year or more before the current climate changes significantly.

While researchers anticipate job gains in the county’s market later this year, unemployment remains a pesky problem. According to the California Employment Development Department, the region’s jobless rate in March was 11 percent — up from a revised 10.7 percent in February, and 2 percentage points higher than March 2009.

“Employment trends have always been a big driver of office vacancy trends,” said Jon Boland, a vice president in the San Diego office of Voit Real Estate Services.

Voit’s first-quarter report on the local market puts the direct and sublease office vacancy rate at 16.34 percent, which is up from 15.89 percent a year ago, and nearly equal to the 16.37 percent during the prior quarter.

With rising vacancies come dropping rents. Boland notes that in a few instances, prime Class A office space in submarkets such as University Towne Center, which may have rented for $3.50 per square foot in a better economy, can be found at $2.20 a square foot.

“It’s giving tenants an opportunity to step up into some very good, newer Class A buildings, and that’s going to be to the detriment of the Class B and older Class A buildings,” said Boland.

Uptick in Sales and Leasing Activity

According to Voit, the San Diego region’s average asking lease rate per square foot (full-service gross) was $2.25 at the end of the first quarter, down 12.45 percent from last year’s $2.57 and 12 cents lower than the prior quarter. The latest average asking rent is well down from $2.76 per square foot, seen in the first and second quarters of 2008.

Experts say there was a notable uptick in overall office property sales and leasing activity in the first quarter compared with a year ago. Voit reports that new office construction has slowed substantially — with 346,636 square feet under construction at the end of the first quarter, about half the level of the prior period. The new leasing helped the region register positive net absorption of local inventory.

Boland notes that the absorption that did occur during the first period, a net of just over 200,000 square feet, got the year off to a good start but barely affected the region’s overall vacancy rate, since companies that moved into new spaces left older ones vacant.

Among the larger leases finalized during the first quarter were Nokia’s lease of 196,734 square feet in Rancho Bernardo, and Mitchell International Inc.’s lease of 141,214 square feet at Governor Park.

Less publicized than the big deals is a trend of corporate tenants “right-sizing” their office arrangements, says Bill Fleck, a senior managing director who does primarily tenant representation for brokerage firm Jones Lang LaSalle in San Diego.

Tenant Due Diligence

For instance, companies currently leasing more space than they are actually using, and who have no plans to use that excess square footage in the near future, are renegotiating their leases so they are responsible for less space at a lower cost. Landlords looking to retain tenants are often willing to open those renegotiations two years or more before the current lease is set to expire.

“A lot of times the landlord would rather negotiate to have that tenant stay in a smaller space, rather than see that tenant just go elsewhere, even if it means the landlord has to take back some of that space,” Fleck said.

Because of continued uncertainty in commercial real estate financing, and industry expectations that many commercial building owners could fall behind on payments to their lenders later this year, Fleck says tenants are compelled to do more due diligence as to the financial health of their prospective landlords.

“The building owner’s lender may have said, ‘We’re not investing any more capital,’ so the money may not be there to support capital improvements and other things that the landlord has promised to the new tenant,” he said.

Despite those lingering issues, the research and brokerage firm Marcus & Millichap ranks San Diego at No. 11 among 44 major metro areas in its latest annual report gauging the economic health of the nation’s office markets. San Diego this year moved up six spots from its No. 17 ranking in 2009.

The report tracks trends for potential office building investors, and ranks metro areas based on forward-looking indicators of supply and demand, including job growth, vacancy and construction rates…Click HERE to view the full artice.
Source: www.sdbj.com