By David Marino
It seems like every time you open the local paper, or read an online commercial real estate promotion in the last few years, it talks about how vacancy is falling and prices are skyrocketing. While we are definitely seeing a tightening in some markets (UTC and Kearny Mesa), in certain product types (wet lab and industrial), and in certain size ranges (big spaces and not small ones), the overall story is really more mixed.
Take the office sector for example. If you look at the availability rates, including all space on the market and sublease space, availability rates are mostly stagnant from what they were five years ago across the major office submarkets. The I-15 Corridor is actually up two percentage points since five years ago, from 15.2% then to 17.1% now. Carlsbad is effectively flat at just over 20% as compared to five years ago, as is Sorrento Mesa at just over 21%. These are not healthy numbers and are relatively staggering given the recovery in the broader regional economy.
Downtown is flat at 17.7% five years ago and 17.8% today, and Mission Valley is the same story at 14% five years ago and 13% today. The only regional office markets with any material improvement over the last five years are UTC, which moved from 11.9% five years ago to 8.6% this year, and Kearny Mesa which moved from 19.5% to 15.5% over that same five-year horizon. But other than UTC, every other office submarket in the region still suffers double-digit availability rates, most into the teens and a few even higher. So, what’s going on?
First, companies are figuring out how to get by with less. Rather than just pay higher prices, many companies are trying to figure out how to get more people into less space. Many companies today talk about office sharing, coworking and employees hot desking based on real time need versus the company carrying dedicated workspace for every employee. Second, technology and cultural shifts over the last five years have caused many relocating companies to move to environments with fewer private offices, smaller private offices and smaller workstations. All of this has increased density in the workplace for most companies that have chosen to relocate and re-design their workspace over the last five years. Third, a factor driving the perception that the market is strong is that larger companies–those with more longevity and credit worthiness–are trading up the quality scale, switching from older buildings into newer ones.
While the office market brokers are excited about tenants leasing 50,000 square feet, those companies, more often than not, are moving from the comparably sized facilities and leaving older generation buildings behind that require significant retrofit and repositioning by that building owner. For the most part, there has been a lot of activity, but it hasn’t resulted in a lot of “net absorption,” (which is the difference between space leased in the market and space given back), in most of the submarkets excluding UTC and Kearny Mesa.
The function of how tight the market is dependent on how big of a tenant you are. While there are three options in UTC for a tenant looking to lease 30,000 to 50,000 square feet, if you were a tenant looking to lease 3000 to 5000 square feet, there are 31 options for you. There is a similar story in Del Mar Heights where there are only five existing buildings that can provide 30,000 to 50,000 square feet, but if you were looking for 3,000 to 5,000 square feet, there are 47 spaces available for your consideration. For office tenants under 10,000 square feet, it’s still good pickings!
The market is a very different story when you look at the regional demand for biotech wet lab space and industrial space. That’s where the real recovery has been. In fact, demand for biotech wet lab space is so strong that landlords in Sorrento Mesa are looking to convert three and four-story office buildings on the Morehouse corridor to wet lab space. This is something similar to what was done in Campus Pointe by Phase 3 Development in their purchase of the former SAIC corporate headquarters office building and its conversion to wet lab for the biotech industry. Be looking for more of that to come in the coming years as office availability rates continue to stagnate in Sorrento Mesa and other submarkets.
Over the last five years, industrial availability rates have collapsed significantly in several of the markets around the county, moving from 10.3% to 5.3% in Kearny Mesa, 12.3% to 6.2% in Otay Mesa, and 14.1% to 7.6% on the I-15 Corridor. Between the manufacturing sector in the region, the growth of breweries around the county and the pickup of cross-border activity in the South Bay, the region’s industrial supply is actually beginning to fill up. This is exacerbated with most submarkets running out of industrial land, and certainly the region’s industrial land supply will be completely built out within the next decade.
The bottom line is that the commercial real estate market is not as strong as everyone would lead you to believe it is. There are still great opportunities, particularly for small to medium size businesses that make up so much of the economy. For larger companies in the region, they are simply going to have to be more flexible about the submarkets they consider and have a long-term planning horizon for when they start the facility acquisition process. For the tenants of the region, San Diego is still a great value and place to be doing business.
David Marino is executive vice president of Hughes Marino, an award-winning commercial real estate company with offices across the nation. One of the top commercial brokers in all of Southern California, David possesses unrivaled, comprehensive market knowledge, and writes regularly about San Diego commercial real estate on his blog, Suburban Scoop. Contact David at 1-844-662-6635 or firstname.lastname@example.org to learn more.