Office Vacancy Finally Returns to Pre-Recession Lows

The office vacancy rate in San Diego has returned to pre-recession lows. According to a new report from CBRE, office absorption in the second quarter surpassed 500,000 square feet and vacancy fell to 10.6%—the lowest rate since the last peak. If absorption follows this trend, the market will likely hit a single-digit vacancy rate by the end of the year. The strong leasing activity was driven largely by organic growth within the market from the defense, life science and financial services industries, which have long been the industry drivers in San Diego.

“Half of the leasing transactions that occurred in the second quarter were from growing tenants, so organic growth in the market,” Christopher Pascale, SVP of CBRE, tells GlobeSt.com. “We have companies here that are growing, and office growth drives office absorption. There is a direct correlation there. The unemployment rate in San Diego is below 3%, which is the lowest that it has been in 20 years. If you couple that with the lack of new construction, which means there has been no overbuilding in this recent upcycle, that results in positive net absorption and lower vacancy rates.”

Pascale says that a single-digit vacancy rate is within reach—and that would be the sign of a very healthy office market. San Diego already has the lowest office vacancy rate in Southern California. “We are almost into single-digit territory, which is a milestone for any office market,” he says. “If we keep up net absorption, I would predict that we will be sub 10% direct vacancy by yearend.”

With strong leasing activity, it is no surprise that rental rates have followed. For the sixth consecutive year, rental rates have increased in the San Diego office market, and last quarter, they climbed 3.9%, up $0.11. “We are at a record-high asking lease rate across the county, and all of the major submarkets are above pre-recession highs for asking rents,” explains Pascale. “The highly amenitized projects are getting the highest rents, and we have noticed that people aren’t afraid to pay high rents when they see value. There is also an employment war going on, and employers are willing to pay more to attract and retain the best talent.”

Despite the strong leasing activity, new development hasn’t increased yet. Rental rates do justify new development, but Pascale doesn’t expect fervent office development in the market. “It is very subjective. REITs have primarily done the building since the last upcycle, and they had the ability to borrow money at a low rate,” he says. “It is hard to get construction loans for speculative office development. Rental rates need to be at a certain level to support new construction costs, and until now they haven’t hit that level. I think that we will start to see more projects coming out of the ground, but people are cautious. We will see new development in very specific locations and very specific product type.”