Has Landlord Pricing Power Disappeared?

Marino: “We’re not seeing this problem everywhere; it’s unique to San Diego because we’re a smaller, more isolated community than these other markets.”

SAN DIEGO—The economy is healthy, but momentum pushing the pendulum toward a landlord’s office market has slowed significantly in the UTC and Sorrento submarkets of San Diego, Hughes Marino ‘s EVP David Marino tells GlobeSt.com. After Marino stated in a recent company report that he feels the San Diego office market is returning to equilibrium after five years of recovery, with availability rates beginning to spike this year, we spoke exclusively with Marino about this trend, the state of the market and where he sees San Diego’s office sector headed in the near future. GlobeSt.com: Do you feel that the pendulum is swinging back toward a tenants’ market in commercial real estate? Marino: It’s more that it has really stopped swinging toward a landlord’s market. It had gone strongly toward the landlords in the last two to three years, and now that pendulum has stopped swinging that way. I don’t want to overstate the softness of the market—it’s not in aggregate a soft market—but landlords are not calling the shots specifically any more. There’s more of a lessening of momentum; the momentum is over. GlobeSt.com: Are you noticing this in other markets besides San Diego? Marino: Not really. We’re not really seeing this in Orange County, Los Angeles or Northern California yet. The markets rate independently, but when the whole economy goes to hell in a handbasket, all the wheels come off. We’re not seeing this problem everywhere; it’s unique to San Diego because we’re a smaller, more isolated community than these other markets. We’re also a fraction of the size of these other markets. And we’re literally located at the end of the road in Southern California. Space consumption is a function of the local companies here and their ability to create jobs and acquire space. The growth around that has slowed, and there has been a whole lot of M&A activity, causing sublease space to hop on the market: the merger between Cushman & Wakefield and DTZ put C&W space back on the market as a result last week. AECOM Technology bought URS , so a lot of engineering space came on the market in UTC as a result of that. The economy is healthy—M&A is a natural by-product of a good economy—but nearly 200,000 square feet was put back on the market, mostly in UTC, last year. GlobeSt.com: When do you foresee landlords hitting a ceiling in terms of purshign commercial rental rates? Marino: In UTC specifically, the Irvine Co. has lowered rents in a number of their buildings. In some of the Irvine Co.’s class-A high-rise buildings, we’re doing deals between 30 cents and 40 cents a foot off today from where we were a year ago. The change is occurring in real time. In Sorrento Mesa, class-A landlords are offering significant moving credits that substantially pay for all furniture, cabling, and moving costs in addition to other TIs. So, the market in real time is already changing to try to capture a little bit of tenant demand out there in UTC and Sorrento. Landlord pricing power is already gone in those markets. GlobeSt.com: In which submarkets do you think this loss of momentum will hit next? Marino: I think Del Mar Heights will be the next domino to fall. They have always had pricing power by being north of the I-5 and 805 merge. But most buildings in Del Mar Heights are unimpressive and lacking in amenities—they have nothing going for them except location. If you moved all of those buildings to UTC, none would be in the class-A category. The premiums that they have bene able to command will be difficult for landlords to keep up—they won’t be able to keep asking for the rent numbers they’ve been able to get for the last year or two. There have already been some major moves out of that market, which is putting space back on the market, with Qualcomm vacating. And American Assets Trust ‘s Torrey Hills project is coming online, competing with Del Mar Heights proper.