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Office property sales down from earlier surge

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Office property sales volumes declined in San Diego County the second and third quarters of 2014, following a first quarter that was the strongest in two years.

A JLL (NYSE: JLL) report generally bodes well for the San Diego office market, while acknowledging potential weaknesses. The countywide vacancy checked in at 14.4 percent according to JLL, notably lower than the 15.9 percent level nationally.

The countywide office property sales volume was down from the $678.3 million figure recorded in the year's first quarter.

JLL tallied $248 million in office property sales in the second quarter and $215 million such transactions in the year's third quarter.

Two transactions accounted for much of the third quarter sales total. In early September a Lionstone Investments entity paid $152.5 million for the 655,643-square-foot San Diego Tech Center in Sorrento Mesa.

The third quarter tally also included Scripps Health's $28.78 million Sept. 29 acquisition of 130,855-square-foot office building at 10790 Rancho Bernardo Road.

This building had been a J.P. Morgan Chase (NYSE: JPM) mortgage processing center that was shuttered within the past year.

JLL stated many landlords in tightening submarkets such as University Towne Centre and Del Mar Heights are raising rents.

The county's overall office rental rates climbed by an average of 5.9 percent, year over year.

The average rental rates in the Del Mar Heights and UTC submarkets ended the third quarter at $3.50 and $2.82 per-square-foot per month, respectively.

Nationally, JLL projected rents will on average climb by 13 to 14 percent over the next 27 months "driven by a new wave of developments priced at 20 to 25 percent premiums, which will trickle down to a reset in market pricing across the board."

JLL tallied 352,856 square feet of net absorption the county in the third quarter, and 623,100 square feet in net absorption through September 2014. This absorption is being helped by landlords sprucing up their space.

"Some owners are beginning to reposition existing product, which is decreasing the supply of cost-effective office alternatives. This in turn is driving rents further up and forcing tenants into less attractive locations," JLL wrote. "With very few transactions for this emerging product type, it remains to be seen whether creative office will be successful in San Diego."

The rents and the confidence are high enough in the UTC area for example, that The Irvine Co. is constructing One La Jolla Center, a speculative 306,000-square-foot office tower at 4655 Executive Drive. The project is slated for completion by next year.

Whether it is in Torrey Pines, UTC, Del Mar Heights or Carlsbad, JLL reported biotechnology/life sciences continue to be major drivers for the leasing of high-quality office space.

Employment in these sectors has increased by 2.7 percent here year-over-year, JLL wrote, adding, "Polaris Pharmaceuticals Celenova Biosciences, and Mast Therapeutics are a few of the companies that signed deals this quarter."

The office market in downtown San Diego still has more than 1.9 million square feet of empty space for a vacancy rate of 16.4 percent.

These figures could be exacerbated when Sempra Energy (NYSE: SRE) vacates about 350,000 square feet in the 101 Ash St. building to go into 320,000 square feet in its new building at 424 Eighth Ave.

The CoStar Group (Nasdaq: CSGP) reported that building is expected to be delivered by the middle of next year.

Countering the Sempra movements is the 250,000-square-foot (gross) Torbati building at 625 Broadway, which is being converted into a residential development.

While there is still considerable lateral movement going on in multiple submarkets in San Diego County, JLL remains upbeat about this market and the nation as a whole.

Nationally, JLL reported that company expansions amounted to nearly half the leasing activity for spaces of 20,000 square feet and larger during the quarter.

"Quarterly occupancy [nationally] trounced the prior high with net absorption totaling 15.7 million square feet topping last quarter's total (which had been the highest of the recovery so far) by 13 percent," JLL wrote.

San Diego may only have a couple of major office buildings under construction -- including a 230,000-square-foot planned building in Hines' La Jolla Commons III in UTC -- but JLL noted an increase in office construction nationally.

"Supply constraints across the United States have prompted another quarterly increase in construction with a total of 71.2 million square feet of office under development," JLL continued.

Put another way, JLL wrote the current national office construction activity is the equivalent of constructing 25 Empire State Buildings at the same time.

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