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Impact fees, demand to determine return of spec office building

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While speculative office building construction appears destined to return to San Diego County, the question is when, where and who will take the first step.

The future of office development was the topic of an Urban Land Institute (ULI ) of San Diego meeting held Tuesday at the University Club.

Shawn Tobias, a Hines director, said first major speculative office building might go up "whenever Donald Bren wants it to."

Bren, The Irvine Co. chairman, is currently weighing when it will be time to develop his 300,000-square-foot La Jolla Center III project in the University Towne Centre (UTC) submarket.

Hines meanwhile has proposed a 230,000-square-foot La Jolla Commons III in the UTC area, but, as is the case with the Irvine Co., is awaiting the time when rents or a guaranteed tenant will justify new construction.

"Is office development back in San Diego? The short answer is no," Tobias said. "But if you look at particular submarkets, rents are on the verge of being where they need to be. Speculative development will be a reality in the very near future."

Tobias added that Del Mar Heights is another submarket that may soon be ripe for new office development.

Kilroy Realty Corp's (NYSE: KRC) One Paseo development in the Del Mar Heights continues to evolve.

It would feature more than a 100,000 square feet of office space, along with housing and retail as conceived, but concerns over traffic at the junction of Del Mar Heights Road and El Camino Real have threatened the project.

Tobias warned that if voters decide to retain up to a 380 percent increase in impact fees on new commercial development next June, it could stifle construction.

Qualcomm (Nasdaq: QCOM) has already said that such an increase might force it to rethink development plans.

More than that, Tobias said companies -- he cited SAIC(NYSE: SAIC) and Websense (Nasdaq: WBSN) -- might announce they are going to pull up stakes and leave.

Dennis Cruzan, co-founding partner of long-time San Diego real estate firm Cruzan|Monroe, shared Tobias' frustration.

"We need to push government in a manner that will attract key talent," Cruzan said. "Other than the weather, we need to ask what we offer as a city."

Cruzan and Rick Reeder, a Cassidy Turley capital markets specialist, said whenever office development does come, it will be markedly different than what came before.

One reason buildings will be different is that LEED (Leadership in Energy and Environmental Design) structures are becoming the norm.

Hines' 414,000-square-foot building for LPL Financial (Nasdaq: LPL) nearing completion at La Jolla Commons, will reportedly produce more energy than it uses.

"Delivering non-LEED space in this day and age is irresponsible," Tobias said.

While it might not command higher rents, LEED can help get a space leased, he added.

Reeder said while there doesn't seem to be a particular demand for LEED space today, it will become more important over time.

Cruzan -- which along with Cigna Investments owns the 300,000-square-foot DiamondView Tower building, said when office construction does pick up at some point, it may not be typical.

"I don't think we're going to see an office tower every freeway exit," Cruzan said. "These are going to be much more micro, but substantive projects."

"These buildings are going to have all new amenities," Reeder said, adding that while parking will continue to be an issue for these buildings, some inconvenience may be overlooked if the amenities are strong.

Cruzan said the new buildings will be demand-driven, and the 60,000-square-foot structure under construction for the Latham & Watkins law firm in Del Mar Heights is a case in point.

"Latham wanted to be in a certain submarket and they were particular about what they wanted in their amenities," Cruzan said. "So much of what we are seeing built today is demand driven. There is a little too much focus on rent."

Reeder said whether it's new construction is new or the existing office buildings, landlords must accommodate shrinking average square footage per employee.

Reeder emphasized that although there are numerous smaller buildings for tenants, they aren't many for a larger corporate tenant looking for bigger buildings and more collaborative spaces. Examples of that are Qualcomm -- with its hundreds of thousands of square feet under construction in Sorrento Mesa -- and Sempra Energy (NYSE: SRE), with the planned 300,000-square-foot headquarters being built in the East Village.

In Cruzan|Monroe's DiamondView Tower overlooking Petco Park, space is being reconfigured into more collaborative spaces.

Reeder said new buildings should break the mold.

For example, he said, while developers think of a campus-style office complex in a low-rise, sprawling sense, there is no reason why that style couldn't be part of a new high rise.

Cruzan said he believes the next generation of office buildings will feel less like a high rise and more like a hotel in what is being offered in the way of amenities.

Reeder said there continues to be much more capital than existing office buildings, particularly of the Class A variety.

Reeder said as the supply/demand imbalance continues, new speculative office buildings will begin to make economic sense in suburban submarkets.

Cruzan noted that with such high barriers to entry in San Diego, even the obsolete buildings, such as what has been referred to as "woody walk-ups" in Mission Valley, still have managed to retain their values.

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