Office demand remains steady in Q3
Behind the Numbers
- Nearly 1 million SF of net absorption has occurred during the first nine months of the year.
- Class A average asking rental rates spiked up $0.09/SF during the quarter to reach $3.41/SF/month. Class A rates are up 3.6% over the past year. Overall average rates for all classes increased slightly to $2.77/SF/month – the highest rate on record.
- Overall countywide vacancy dropped slightly to 10.4% – the lowest level in 14 years.
Net Absorption
San Diego County net absorption for Q3 2019 equaled 263,134 SF. Class A inventory recorded the most activity with 180,048 SF of net absorption, while Class B recorded 144,095 SF. Class C demand decreased by 61,009 SF of negative net absorption.
Scripps Ranch posted the greatest net absorption in Q3 with 196,478 SF. This was primarily driven by the completed construction and occupancy of MedImpact in the second building of 158,995 SF Watermark office project. Additionally, TrellisWare Technologies expanded into an additional 26,920 SF at Summit Pointe.
Sorrento Mesa (+91,013 SF) had the second highest level of absorption. Notable occupancies included Omniome leasing 74,558 SF at Sorrento Highlands and Housecall Pro moving into 34,397 SF at Enclave Sorrento. Additionally, Anokiwave occupied 21,623 SF at Sorrento Towers.
Vacancy
The countywide vacancy of 10.4% in Q3 2019 is a 14-basis point decrease from the prior quarter. Direct and sublease vacancy rates are 9.6% and 0.8%, respectively.
Overall vacancy in Downtown increased to 15.2% in Q3, driven by negative net absorption of 28,551 SF. Overall vacancy in the Suburban markets dropped to 9.7%. Within the core submarkets, Kearny Mesa (7.0%) and UTC (7.5%) posted the lowest rates and Carlsbad (15.9%) had the highest rate.
Countywide Class A and Class B vacancy rates ended the quarter at 11.8% and 10.0%, respectively. Class C posted the lowest vacancy rate at 8.2%. Most of the absorption in recent quarters has been in Class A, heavily amenitized properties. By year-end, overall vacancy could conceivably fall below 10% with consideration to the current rate of demand.
New Supply
Only one new building was completed in Q3 – MedImpact’s 158,995 SF second building in The Watermark project in Scripps Ranch. There are currently four projects totaling 636,484 SF under construction countywide, of which 98,000 SF is expected to be completed by year-end. 2019 will have the second highest level of new construction completed in a decade.
The aforementioned projects currently under construction include One Paseo - a two-building 288,484 SF project being developed by Kilroy Realty in Carmel Valley (76% pre-leased), Sorrento Summit III – a 28,000 SF project pre-leased to Nuvasive and being developed by HCP, Inc., Cubic’s new 250,000 SF two-building headquarters expansion on Balboa Ave in Kearny Mesa, and Snap-On Inc.’s 70,000 SF build-to-suit on Babcock St in Rancho Bernardo.
Rising construction costs, limited developable land, and pre-leasing requirements to secure financing will limit the future development of new office space. However, there has been a trend in renovating existing flex buildings to become fully built-out office space. This trend will continue to be favorable considering the high cost and low availability of raw land makes new ground-up development prohibitive, in many cases. Additionally, the ability to deliver newly renovated space to market rather than brand new development is considerably faster. Renovating existing flex buildings is very appealing to technology companies and other users who feel that a more ‘creative’ office environment is much more appealing than traditional office space.
Annual net absorption has been consistently strong, outpacing new construction over the last nine years. Unlike the years prior to the last recession, San Diego’s office market is not at a risk of over-building, even if the national economy was to slow or contract in the next couple of years.
Trends, Forecast & Outlook
Vacancy will continue to decrease in Q4 2019, pushing the rate toward 10% by year-end. The current pace of demand for best quality office space will continue to exceed new supply for the well into next year. Assuming the local economy continues to remain strong and the current supply-demand trend persists, vacancy could drop to its lowest level in 15 years. Average asking rental rates will continue to increase at 3% to 4% annual rate.
