Office market faces uncertainly during global pandemic
- 207,962 SF of negative net absorption recorded countywide in Q1 2020 - the first quarter of negative net absorption in nearly three years.
- Class A average asking rental rates remained flat during the quarter at $3.43/SF/month. However, overall average rates for all classes increased by 3.6% to $2.91/SF/month – the highest rate on record, driven by increases in Class B and C rents.
- After dropping below 10% for the first time in more than 13 years, overall countywide vacancy increased to 10.5% in Q1.
San Diego County net absorption for Q1 2020 equaled a negative 207,962 SF. Class A and B demand contributed to drop in demand with 116,607 SF and 91,842 SF of negative net absorption, respectively. Class C demand remained flat.
The drop in demand was concentrated in few submarkets, primarily Miramar (-70,908 SF), Carlsbad (-63,639 SF), Downtown (-57,570 SF), and South Bay (-45,105 SF). But in each of these submarkets, the moveouts were concentrated in only a few buildings. Notably, the Fashion Institute of Design and Merchandising vacated 32,563 SF at DiamondView East Village in Downtown and Verve Wireless vacated 29,367 SF at MAKE in Carlsbad. While most of the move-outs occurred early in Q1, it is likely that Q2 will see additional negative demand as a result of the effects novel coronavirus (COVID-19) has on the economy and specifically office tenants.
Potentially, we could see some business closures and space contraction due to the pandemic in the next couple of quarters, but it is not entirely certain to what magnitude that will be.
The countywide vacancy of 10.5% in Q1 2020 is a 73-basis point increase from the prior quarter. Direct and sublease vacancy rates are 9.7% and 0.7%, respectively.
Vacancy in Downtown increased from 15.1% in Q4 2019 to 19.5% in Q1 2020, driven partially by negative net absorption of 57,570 SF. Additionally, two buildings under major renovation – 1010 2nd Ave and 1420 Kettner Blvd – were completed. This added 468,078 SF back into the Class A inventory along with 95% vacancy.
Overall vacancy in the Suburban markets increased just 19 basis points to 9.2%. Within the core submarkets (those with more than 5 million SF of inventory), UTC (4.7%) and Kearny Mesa (5.3%) posted the lowest rates and Downtown (19.7%) and Carlsbad (15.9%) had the highest rate.
No new buildings were completed in Q1 2020. However, there are currently six projects totaling more than one million SF under construction countywide. These projects include three being developed by Kilroy Realty: One Paseo - a two-building 288,484 SF project in Carmel Valley (90% pre-leased), the 160,400 SF 9455 TCD building in UTC preleased to Apple, and the 204,754 SF 2100 Kettner building in Little Italy (Downtown submarket). Also, under construction are Sorrento Summit III – a 28,000 SF project pre-leased to Nuvasive and being developed by HCP. A 125,000 SF build-to-suit for Cubic on Balboa Ave in Kearny Mesa is being developed by Cisterra. This is the first of two buildings being built for Cubic that will eventually total 250,000 SF. Finally, ground was broken on two buildings in the Aperture Del Mar project in Carmel Valley, totaling 217,235 SF and being developed by Lincoln Property Company.
New ground-up construction has been subject to high demand. However, the current COVID-19 pandemic will likely delay the start of new projects that are proposed throughout the county until there is a better understanding of what office demand will be until the pandemic subsides.
Trends, Forecast & Outlook
As we publish this report, the U.S. and the world at large are facing a tremendous challenge, the scale of which is unprecedented in recent history. The spread of the novel coronavirus (COVID-19) is significantly altering day-to-day life, impacting society, the economy and, by extension, commercial real estate.
The extent, length and severity of this pandemic is unknown and continues to evolve at a rapid pace. The scale of the impact and its timing varies between locations. To better understand trends and emerging adjustments, please subscribe to Colliers’ COVID-19 Knowledge Leader page for resources and recent updates.
Under the current conditions, the office market faces significant challenges as many companies considered “non-essential” require their workforces to work from home as well as co-working operators configuring their spaces to accommodate “social distancing.”
As the pandemic subsides over the course of the year, office users, operators, and owners will not only need to contend with the immediate effects of the COVID-19 aftermath on their businesses, but at long-term effect on office workplace culture, work-style, and space utilization.