SOUTHERN CALIFORNIA—With options for large blocks being few amid increasing demand in San Diego and class-B making up the bulk of absorption in San Diego, office tenants seeking this space might have some trouble finding it. According to a recent report from NKF, in San Diego, large-block space options are few, and demand will likely increase with growing venture-capital and private-equity funding in the market.
JLL reports that in San Diego, converted and retrofitted buildings are helping to satisfy big-block demand in the I-15 Corridor and North County West clusters. But tenants such as WeWork, signed for 43,032 square feet in UTC in Q4 2017, are looking to expand their presence in the region, and it's uncertain if they will be able to find the space they need to do so.
It all depends on the submarket, Patrick Ashton, senior research analyst for JLL, tells GlobeSt.com. “For example, Sorrento Valley, with a decent amount of older-generation flex buildings, was the first to convert properties into creative offices for the smaller to midsize range; now we are starting to see this happening on a larger scale with Mission Valley's former San Diego Union-Tribune building being rebranded to Amp&rsand, as well as the former HD Supply building now rebranded as Summit Pointe in Scripps Ranch.”
Ashton adds that developers are essentially seeing renovating and retrofitting buildings as a way to stay competitive and appeal to the more modern tenant. “San Diego has development barriers compared to other markets, with topography restraints, shortage of construction labor and project hurdles that take a year and half to move forward.” With this potent mix of factors not making it easy for developers to break ground in a timely manner and high tenant demand, Ashton says JLL expects this trend to renovate existing office buildings to continue for the next few years.
Meanwhile, in Orange County, class-B space is disappearing fast. An NKF report reveals that class-B office inventory comprised 72.4% of 2017's net-absorption gains in the market, fueled by the fact that average rent in this segment is 23% lower than class-A space, continuing to appeal to budget-conscious tenants. Also, nearly 80% of the office net absorption for the year in San Diego came from class-B space.
In August 2017, PM Realty Group SVP Oliver Fleener told GlobeSt.com that with up to 30% price differentials between class-A and class-B office space and conversions and renovations being better suited to those smaller buildings, it's not surprising that absorption is greater in that space within the Orange County market. “When the market tightens, people start to go back to class-B product—they probably shouldn't have been in class A to begin with,” said Fleener. He added that in 2012, when the market was soft, there was a flight to quality, and since the average lease term is five years, renewals would have come into effect in 2017—meaning more tenants have been looking for space in the market over the last year.
Stay tuned to GlobeSt.com for an interview with NKF senior managing director George Thomson on how tenants seeking class-B space are dealing with a possibly decreasing inventory.
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Carrie Rossenfeld
Carrie Rossenfeld is a reporter for the San Diego and Orange County markets on GlobeSt.com and a contributor to Real Estate Forum. She was a trade-magazine and newsletter editor in New York City before moving to Southern California to become a freelance writer and editor for magazines, books and websites. Rossenfeld has written extensively on topics including commercial real estate, running a medical practice, intellectual-property licensing and giftware. She has edited books about profiting from real estate and has ghostwritten a book about starting a home-based business.
