San Diego County | Office
Behind the Numbers
- In 2020, more than 1.6 million SF of negative absorption was amassed.
- Countywide overall vacancy increased 95 basis points (BPS) in Q4 to reach 12.9% - the highest level since 2015.
- After 30 quarters of continuously upward trending rental rate increases, the countywide average asking rental rate stabilized at $2.93/SF/month by midyear and remained flat at year-end.
- Increased demand for life science space has been bolstering the conversion of existing office space, which will mitigate any long-term vacancy trend over the next few years.
- As office supply and sublease opportunities exceed demand, tenants will experience more favorable leasing terms and concessions in 2021.
Overall office demand has been trending downward countywide since the first quarter of this year. In Q4, 600,941 SF of negative net absorption was recorded bringing 2020 total net absorption to a negative 1.63 million SF. The almost yearlong COVID-19 pandemic continues to force businesses continue to implement work-from-home (WFH) policies that have depressed day-to-day office space utilization. Additionally, some tenants have experienced permanent layoffs, giving back unneeded space as they negotiate lease renewals.
2020 had the largest annual decrease in demand, as measured by net absorption, recorded in the 25 years that Colliers has tracked the local office market. The record negative activity even exceeded by 134% the prior worst year of 2008 (-695,416 SF), which was during the period of the Great Recession.
The decrease in demand affected all office classes countywide and a vast majority of submarkets. Much of the increased vacancy was due to smaller tenants vacating space across nearly all submarkets, however there were a few notably large move-outs. Wawanesa Insurance vacated 152,944 SF at their two previously owned buildings at 9040 and 9050 Friars Road in Mission Valley. Wawanesa relocated into 75,000 SF at 7650 Mission Valley Road in Q3 and the previously occupied project is being renovated by the Casey Brown Company. Illumina vacated 73,716 SF at 4747 Executive Drive in UTC, which is being marketed as sublease space. Arrowhead Insurance vacated at full floor (-23,271 SF) at 701 B Street in Downtown San Diego, Atlazo vacated 17,989 SF at 4250 Executive Square in UTC, and YMCA vacated 15,823 SF at 3333 Camino Del Rio S. in Mission Valley.
In Q4, Kearny Mesa posted the most positive net absorption (+54,873 SF), bolstered by Cubic Corporation’s completion of two build-to-suits buildings totaling 250,000 SF. Only nine other buildings across the county posted positive net absorption exceeding 10,000 SF. The largest move-ins included the law firm of Lewis Brisbois Bisgaard & Smith LLP (+36,734 SF) at 550 W C Street in Downtown San Diego and Zeku USA (+19,105 SF) at 3570 Carmel Mountain Road in Carmel Valley.
Negative absorption in most submarkets throughout the County has caused the vacancy rate to increase to 12.9% at the end of Q4. This was nearly a one-point increase over a three-month period. Direct vacancy increased to 11.7% (+75 BPS) and sublease vacancy increased to 1.2% (+20 BPS).
Sublease vacancy of 1.2% of the total office inventory is double that that of average rate of 0.6% over the last three years. Sublease vacancy reached a 15-year of 2.5% in Q4 2007 but dropped steadily and leveled out at 0.7% up until early 2020. Direct vacant space has been where most of the increases had been realized in 2020.
Vacancy has been accelerating in some of the core office markets such as Carlsbad (17.3%) and Mission Valley (15.0%), but the biggest increase has been in Downtown San Diego where 357,917 SF of negative net absorption in 2020 has driven vacant space to make up nearly one-quarter (23.5%) of the total office base.
Cubic Corporation’s two-building build-to-suit headquarters at 9333 Balboa Avenue in Kearny Mesa was the only project completed during Q4. Both buildings were 125,000 SF in size and replaced former industrial building on part of the site. There are currently nine buildings totaling more than 2 million SF under construction countywide.
Fortunately, San Diego County is not at the risk of being overbuilt in the near term. Of the 538,484 SF that was completed in 2020, only 5.3% remained vacant at year-end. Negative net absorption in the existing base was the sole reason for the increase in vacancy during 2020.
Another 1.05 million SF is slated for completion in 2021. This is far less than the 1.8 million SF average annual completion in the decade prior to and during the Great Recession (2000-2009). During the peak of the recession, vacancy reached nearly 18% countywide and declined over the following decade (2010-2019) as inventory could lease up, while new construction averaged under 450,000 SF-a-year on average.
Trends, Forecast & Outlook
While the pandemic has had adversely negative effects on office demand, the same cannot be said across all commercial property categories countywide. In fact, the retail sector had seen the most increase in vacancy for the year, increasing from 3.1% in 2019 to 4.1% in 2020. The industrial sector actually had a strong year with 1.64 million SF of positive net absorption.
Therefore, the effects of the pandemic are not solely manifested in public-health implications alone but have amplified and accelerated new considerations on how office space is used. Prior to the pandemic, trends in co-work/flexible space and WFH were already in the infancy of a long-term office trend, but the pandemic has precipitated this trend up to many more businesses and their workforce. Future considerations for 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, workstyle, and space utilization.
A bulwark against a potential diminishing of office demand countywide is the growing demand in the life science sector, driving up demand for more buildings that will accommodate laboratory and R&D space. In 2020, life science and wet lab space saw vacancy drop by 269 BPS to 7.0%.
New ground-up development for life science space is limited not only by available land, but also by development costs. This has drawn interest for additional inventory being converted from traditional office space as well as a focus on seeking alternate submarkets for new development.
In Q4, Longfellow Real Estate Partners purchased the “The Foundry” – a 281,000 SF two-building Class A office mid-rise project in Sorrento Mesa – with plans to convert the project to life science space. Additionally, Longfellow is converting 23-buildings with 660,000 SF of R&D space into high-end lab space in the neighboring Sorrento Valley market. Over the next year, we can expect more redevelopment of office space and ground up life science construction.
With the promise of a new vaccinations being administered over the first half of 2021, there is a potential for many employees to migrate from their current WFH situations back to the office. After over a year being away from the office, the need to be in an office environment for increased productivity, collaboration, socialization, and even mental well-being will restore some – but not all – of the 2020s lost demand for office space.
Fortunately, San Diego retains a talented workforce and innovative industries that are at the forefront of growth and innovation nationwide. It is the reason San Diego ranks third in the nation for life science employment and one of five metropolitan areas that comprise over 90% of the tech jobs nationwide.