MARKET HIGHLIGHT, AUGUST 2009

SAN DIEGO

Sunny San Diego has shown that it’s not impervious to the economic damper, but smart real estate players still have their fingers on the city’s commercial real estate pulse, waiting for that bright recovery.

Retail

San Diego has historically been a strong retail market with low vacancy and barriers to entry that restrict the supply of new centers. However, the market has not been immune to these difficult times. Rising unemployment and decreased home values have made consumers more cautious, leading to lower sales volumes for many retailers and restaurants creating slightly more vacancy throughout the area.

Expo Design Center, Linens ‘N Things, Circuit City and Mervyns are just a few of the big boxes that sit empty along with several former gas stations, Starbucks Coffee, Banner Mattresses, Baja Fresh and La Salsa locations. However, these vacancies created opportunities for Wal-Mart, Kohls, Best Buy, yogurt shops, taco shops and others to enter projects or trade areas that had proven difficult to enter. Many of these former restaurant locations still include the furniture, fixtures and equipment and have created excellent opportunities for new tenants to reopen with little upfront investment. This is particularly true in South County as many experienced restaurateurs and other business owners from Mexico are crossing the border to open businesses.

Tenants such as Autozone, Chase Bank, CVS/pharmacy, Gamestop, 7-Eleven and Five Guys are now taking advantage of the lower rents and increased landlord concessions to enter the area and/or expand their market share. Others like Vons, Petco, Staples and Anna’s Linens are expanding by shrinking their prototype size.

New development has slowed considerably. There are only a handful of projects currently under construction, including Whole Foods Marketplace in Encinitas, The Paseo in Carlsbad and the Mission & Douglas Center in Oceanside. Many other proposed projects seem to still be a year or more off, including the proposed Mercado del Barrio by Shea Properties adjacent to the Coronado bridge, Shamrock Group’s development of the vacant land adjacent to Las Americas Outlets in San Ysidro, the redevelopment of Balboa Mesa in Clairemont by Lupert-Adler, Terramar Retail Centers’ redevelopment of the Old Police Headquarters downtown and several projects by Sudberry Properties in National City and Scripps Ranch, as well as the Quarry Falls project in Mission Valley, a master plan that includes approximately 4,800 residential units, 500,000 square feet of office space and 500,000 square feet of retail.

San Diego’s investment market has been very quiet since late 2008/early 2009 as most investors are sitting on the sidelines waiting to see what happens with the capital markets and the maturing commercial loans coming due in the next several years. Although numerous projects are currently on the market, most buyers are still waiting for prices to drop further.

All things considered, San Diego still maintains an impressive overall vacancy rate of less than 5 percent, there are several exciting projects on the horizon, it has a diverse economy and will always be one of the most desirable places to live. As a result, San Diego’s retail environment will weather this storm and, in the long run, will remain one of the strongest markets in the country.

— Stewart Keith and Jon Horning are senior vice presidents at Flocke & Avoyer Commercial Real Estate in San Diego.

Office

As a result of the global economic decline, San Diego’s office market is exhibiting the same symptoms found in every office market across the country: vacancy rates are increasing, forcing decreases in rent and an increase in concessions. Property incomes have subsequently declined, causing property values to follow suit. However, despite lower pricing, buyers remain hesitant, uncertain of how deep this slide in the real estate cycle will go.

San Diego’s office vacancy rate increased by 24.2 percent between second quarter 2008 and second quarter 2009. During the same period, the average asking full-service gross lease rate per month per foot decreased by 10.51 percent while combined sales and lease activity declined by 32.33 percent.

The majority of the declining leasing activity in the marketplace today is from companies that are forced to be active due to the abundant consolidation of businesses and the expiration of leases. With limited favorable financing available, buying activity has declined as well, with most firms sitting on the sidelines, watching the market and waiting for some signs of stability.

Nonetheless, there are exceptions to the rule. Owner-user sales are continuing to close, albeit at a much slower rate than prior to the downturn, because SBA lenders remain active and continue to finance buyers that will occupy 51 percent or more of a property. Furthermore, some industries, such as education, are flourishing in this economy and taking advantage of these low lease rates and expanding. Demand for education has risen alongside unemployment as the workforce has greater time and a greater need to enhance its skills. As a consequence, the largest office lease in 2008 and the largest lease so far in 2009, totaling a combined 550,000 square feet, were both signed by the San Diego-based educator Bridgepoint Education.

Exceptional opportunities therefore exist in San Diego’s office market for both tenants and buyers. Additionally, as more commercial assets fall prey to the declining economy, the inventory of available office space will continue to grow throughout 2009 and well into 2010, further increasing the potential for buyers and tenants to enjoy discounts at the levels seen in the mid-1990s. Subsequently, property values will fall further and investment will slowly increase as prices adjust accordingly. Nonetheless, stability should return in 2011, and San Diego’s office market will once again begin to thrive, as the pleasant climate and high quality of life draws more business and diversity to the area.

— Bob Salgado is a vice president in Voit Real Estate Services’ Office Brokerage Division in San Diego.

Industrial

San Diego County’s 192 million-square-foot industrial inventory has traditionally maintained healthy occupancy, but the first half of 2009 has pushed industrial vacancies to their highest point in the past 5 years. Largely due to the weakened economy, the San Diego industrial sector experienced a direct vacancy rate spike from 7.8 percent at the beginning of the year to 9 percent at mid-year. Although there was moderate construction activity (777,000 square feet of deliveries), this jump was the direct result of lower tenant demand.

As expected, net absorption and market growth have been negative as more tenants reduced their occupancy needs or moved out of existing space. Net absorption totaled negative 2 million square feet at mid-year, approximately 65 percent of which occurred during the second quarter.

Overall industrial leasing activity decreased from 786,560 square feet in first quarter 2009 to 617,646 square feet in the second quarter. The drop in tenant demand and leasing activity has also applied downward pressure on rental rates, pushing the average asking lease rate for all combined industrial product types from $1.02 per square foot per month as recorded in first quarter 2009 to $0.97 per square foot per month in the second quarter.

Several notable lease renewals during the quarter include Lockheed Martin for its 121,800 square feet of corporate headquarters space in UTC and Sony Online Entertainment for its 110,308 square feet of R&D space in Miramar.

Marking the largest industrial sale in the second quarter, Convoy – Ronson Plaza and Industrial Park in Kearny Mesa sold for $12.25 million. Built in 1973, the 104,213-square-foot project comprises seven single-story, multi-tenant industrial buildings.

According to Torto Wheaton Research, “the short-term forecast calls for an overall decline in manufacturing and distribution workers, and total net absorption is forecast to lag supply during the same period” in San Diego County. The recovery period will likely begin at either the end of 2010 or early 2011, with industrial employment and net absorption levels returning to a positive trend.

— Jed Stirnkorb and Brent Wright are senior vice presidents and Matt Pourcho is a senior associate for CB Richard Ellis in San Diego.

Multifamily

The San Diego multifamily market is clearly feeling the effects of the recession. Countywide rental occupancy stood at 93.8 percent at the end of first quarter 2009, a drop of nearly 2 percent from a year ago. Overall rents dropped 0.6 percent year-over-year, with rent losses accelerating in early 2009. With continued job loss and record-high unemployment, this trend will continue for the balance of 2009 and into 2010. Demand has lessened because of people doubling up, recent college graduates staying at home and residents opting to buy instead of rent.

Between April 2008 and March 2009, 1,033 units were delivered representing less than a 0.5 percent increase in supply. Notable recent completions include H.G. Fenton’s 254-unit Aquatera property in Mission Valley and Fairfield Residential’s 230-unit Pravada at Grossmont, located in La Mesa on the trolley line.

Of properties with 50+ units, there were 10 sales in the first half of 2009, down 53 percent compared with first half 2008. Notable sales include Northwestern Mutual Life’s 424-unit Villages of Monterey for $52 million and the 234-unit Montecito Village for $32 million. Both properties were located in Oceanside and sold to Prime Property Capital. The pricing reflects new market metrics, with roughly 80 percent new debt and strong positive leverage.

Don’t expect to see a large number of REO or distressed properties based on the relative good health of San Diego’s multifamily market and the availability of attractive debt from both FNMA and Freddie Mac. It is likely that overall transaction volume will continue at relatively low levels for the balance of 2009 and probably 2010. Once employment picks up, look for a very quick turnaround and strong rental growth due to the lack of new supply and pent-up demand.

— Kevin Mulhern, Dixie Hall and Rachel Hemingway are senior vice president, first vice president and associate, respectively, for CB Richard Ellis in San Diego.

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