The Next Wave of Office Will Focus on Product

Oesterblad: “The attraction to mixed-use, highly amenitized environments is not just a trend; it’s here to stay.”

SAN DIEGO—Specific San Diego submarkets will be less important than the type of product in demand during the next office cycle, with mixed-use , highly amenitized environments continuing to rule the day, CBRE ‘s San Diego-region VP Jeff Oesterblad tells GlobeSt.com. The firm recently released a report about the local office market that showed strong absorption and record-low vacancy rates. “Downtown San Diego, without question, has seen a tremendous amount of velocity as of late,” Oesterblad tells us exclusively. “More companies are finally taking advantage of all that Downtown has to offer—an array of walkable amenities , easy access to public transportation, proximity to a well-educated workforce (more than half of the Downtown San Diego residents have a college degree) and a true live-work-play environment. Combine that with the fact that Downtown’s largest demographic population (the Millennials ) is looking for all those things in their own backyard, and you can see how Downtown is a recipe for success.” Oesterblad adds that, in his opinion, the next wave is going to be more product oriented rather than submarket oriented. “ Alexandria Real Estate has done an exceptional job catering to tenants’ needs and has been rewarded accordingly. Liberty Station has created a true destination that lives and breathes from sunrise to well into the night. Kilroy Realty has grandiose plans to continue the trend with One Paseo . The attraction to mixed-use, highly amenitized environments is not just a trend; it’s here to stay.” According to CBRE’s research, the San Diego office market improved as overall vacancy fell to 12.5%, a new post-recession low. This improvement was driven by more than 660,000 square feet of positive net absorption in Q1, which exceeded total net absorption in all of 2015. In central-coastal submarkets, record rents were achieved, signifying declining supply amid continued demand for space. CBRE also reports that sales activity was strong in the first quarter, with $648.5 million in volume, according to RCA—greater than both Q4 2015 ($513.5 million) and Q1 2015 ($377.8 million). The $262.3-million sale of the Intuit campus along the 56 Corridor, totaling 465,812 square feet, accounted for more than 40% of sales volume this quarter. Two Downtown towers also traded; 525 B Street was purchased by LaSalle Investment for $122 million, and 530 B Street was purchased by Bosa Development for $53.2 million. The market for class-A office space continued to tighten during Q1, driving demand for class-B product, says CBRE. In Q4 2015, most of the positive activity came from class A; however, this quarter, there was more activity among class-B product, which accounted for 59.9% of the overall net absorption. “The San Diego office market is healthier than it has been in years, with nearly every class-A and class-B submarket in the county being at, or near, peak historical rents,” says Oesterblad in the report. “The class-A arena continues to perform well, but the spotlight shined brightly on the class-B market during the first quarter, notching nearly twice the net absorption as its class-A counterpart. The class-B sector will likely narrow the rent gap between it and the class-A sector and is expected to perform well for the remainder of the year as class-B projects continue to be re-positioned and amenitized. Leasing activity should remain strong for the rest of the year given the current demand in the market and the strengthening economy that persists.” Also during Q1, asking rates increased across all office classes and were up 10.2% year over year, resulting in the sixth consecutive quarter that rates have increased. Del Mar Heights continued to command the highest asking rate of $4.20 per square foot, full service growth (FSG); more than 55% of the available buildings in DMH had asking rates of $4 per square foot or higher. Overall vacancy fell to 12.5% in the first quarter, the lowest rate since Q3 2006. The largest decrease in vacancy occurred among class-B product, where the rate improved 120 basis points) quarter over quarter to 13.5%. Net absorption in the San Diego office market was 660,834 square feet during Q1, the largest quarterly net absorption figure in more than a year. Notably, the positive net absorption that quarter surpassed annual net absorption for all of 2015 by nearly 20,000 square feet. Central San Diego accounted for 77.6% of net absorption, driven by Dexcom in Sorrento Mesa, Jones Day and Dentons in UTC, Lifewave in Scripps Ranch and the County of San Diego in Kearny Mesa. CBRE reports that there were no office deliveries or new construction activity this quarter; however, 262,908 square feet of office space is currently under construction. The majority of this construction is in Central San Diego—most notably, Eastgate Summit in UTC (64,832 square feet) and Torrey Pointe in Del Mar Heights (92,018 square feet.). Spec buildings comprise 75% of office-construction activity, signifying confidence in the future of the market. In Sorrento Mesa, three R&D buildings at 5889, 5893 and 5897 Oberlin Dr. were reclassified to class-B office, adding 62,700 square feet to the office inventory. In an effort to attract tenants and compete with more-progressive buildings in the market, landlords see older obsolete or opportunistic industrial buildings as the perfect canvas for the type of open collaborative office space many tenants are beginning to expect.