Office Vacancy Hits Lowest Levels in a Decade

The San Diego office vacancy rate is hitting record lows for this cycle. According to a new report from Colliers International, the vacancy rate in the first quarter was 11.4%—relatively flat over a year ago, but the lowest since the third quarter 2006, when the office vacancy hit 9.9%. Not surprisingly, rents have also increased as a result of the decreasing supply to $2.66, up from $2.51 a year ago, and absorption was up significantly to 157,912 square feet from negative 58,325 square feet a year ago. To take a closer look at the market and leasing activity, we sat down with Tim Cowden, SVP at Colliers, for an exclusive interview.

GlobeSt.com: What is driving the vacancy rate to record lows this cycle?

Tim Cowden: In general, we have limited inventory coming online, and each building is getting more difficult to build. San Diego County is reaching its development saturation, and we are getting to the point where we have to tear down properties to build new ones. That being said, we are really seeing all businesses firing on all cylinders. We have full employment and business is good, pretty much across the board. Barriers to entry of additional product when combined with good solid business growth results in shrinking vacancy rates and rising rents.

GlobeSt.com: Which San Diego submarket has seen the most growth this cycle?

Cowden: In Downtown San Diego, which is where I focus, is the healthiest that I have ever seen. When you look at pure stats of vacancy and office, they don’t tell the whole story. Effectively, if you had a tenant looking for space, the effective vacancy rate is 8.5% in class-A, 5% in class-B and 1.5% in class-C product. We have also had a 25% rent spike over the last two years. This is the result of supply and demand. We have seen a phenomenon where class-B and class-C product that has been renovated into creative office is now in higher demand than class-A office space, and we are seeing an interesting phenomenon where if you have the right class-B or class-C building in a creative configuration, you will draw higher rents than you do in class-A.

GlobeSt.com: Which industries are driving the absorption of renovated class-B and class-C office space?

Cowden: All of the industries in Downtown San Diego, but tech companies are expanding hand over fist. We don’t have a large headquarters presence in San Diego, but we do have small companies that are in those niches and are an example of the Internet explosion that allow these companies to locate anywhere. A lot of the millennials in these niches don’t own cars, so they are walking or biking or Ubering to work. We are seeing these guys expand and create an environment where they would rather be in a two or three-story building with the urban grittiness. They would rather have that than be on the 30^th floor with stunning views.

GlobeSt.com: What is happening in the class-A market?

Cowden: Class-A rents are rising as well, because the whole market is rising. In the suburbs, we have added some product over the last few years, and there are areas where we can add new office inventory. In Downtown San Diego, that is very hard. You really cannot add a two or three-story building because the land basis is too high. This is another factor in the vacancy of class-B and class-C. We have reduced the class-B and class-C inventories due to the construction of residential towers. Several small buildings totaling 100,000 square feet have disappeared under construction cranes has further added to the fact that we have less inventory Downtown to satisfy this need. Class-A buildings are trying to create the equivalent of creative space to attract tenants to their buildings, but they can’t totally deliver the environment because they don’t have the same campus setting.

GlobeSt.com: Are you seeing this trend in other San Diego office markets as well?

Cowden: In the suburbs, we are seeing repositioning of some flex buildings that are concrete tilt-up construction. Those are being rehabbed into creative rotation and feel because developers are realizing that there is a lot of action in this niche. There has been some degree of success in the denser urban submarkets, but they haven’t seen a 25% rent spike. Part of that is because Downtown San Diego had lagged in rents over the last 10 years.