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San Diego commercial real estate performs well in first half of 2004

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Office overview

During the first half of 2004, San Diego's office market witnessed an increase in demand for space primarily from smaller and mid-sized tenants.

Currently, larger blocks of office space are hard to come by, as only two spaces over 75,000 square feet are immediately available for lease.

Consequently, vacancy rates continued to trend downward and net absorption posted a positive gain for the seventh consecutive quarter.

Rental rates remained steady during the first half of the year, while construction activity was solid as approximately 300,000 square feet of new construction was delivered to the market, year-to-date.

Office vacancy

San Diego's office market continued to gain momentum as the vacancy rate dropped from 11.5 percent at the beginning of the year to 10.7 percent at the end of the mid-year, representing a 7.8 percent decrease.

This was the fourth consecutive quarterly decline since its recent eight-year high of 12.1 percent at the end of mid-year 2003.

Net absorption levels remained strong as more than 405,000 square feet posted during the second quarter, bringing the year-to-date total to nearly 700,000 square feet.

Office lease rates

The average asking lease rate for all classes of space in San Diego County increased during the quarter from $1.90 to $1.92, while Class A lease rates rose from $2.15 to $2.23 over the same period.

The highest average asking lease rates were seen in Torrey Pines and University Town Center with $2.99 and $2.68, respectively.

According to a recent report released by Torto Wheaton Research, a business unit of CB Richard Ellis, asking lease rates are expected to increase by approximately 5 percent during 2004.

Office construction

New office developments under construction total nearly 1.6 million square feet, approximately 47.3 percent of which are in the Temecula and downtown submarkets.

The most notable project under construction is the Broadway 655 building located in downtown San Diego.

With an expected delivery date of June 2005, this 23-story 426,000-square-foot building, with 372,000 square feet of Class A office space, will represent the first significant downtown office delivery since One American Plaza (569,000 square feet) in 1991.

Office outlook

The most recent report by Torto Wheaton Research suggests office employment is expected to grow 4.2 percent per year over the next two years -- though this growth will be lower than the long-term average of 4.3 percent per year.

Rents have declined 2.1 percent during most of 2002 and 2003 which, combined with the forecasted job growth, will help to lift absorption in the coming years.

Net absorption is expected to average nearly 2.3 million square feet per year, while supply is expected to average 721,000 square feet, lagging net absorption by the end of 2005, vacancy rates are forecasted to improve, dropping to 6.8 percent, while rents are forecasted to rise approximately 11.0 percent.

Industrial overview

Demand for industrial space was strong during the first quarter, and continued to pick up momentum during the second quarter of 2004.

This prompted a sharp decline in vacancy rates and considerable gains in net absorption. The growth was most evident in Central San Diego as 57.8 percent of the San Diego County's net absorption activity occurred in three Central San Diego submarkets, Torrey Pines (292,000 square feet), Rancho Bernardo (229,000 square feet) and Miramar (113,000 square feet).

Gross absorption was also strong during the quarter while average asking lease rates also witnessed a modest increase.

Development activity has picked up considerably since the beginning of the year as more than 3.1 million square feet is under construction, 1.9 million square feet (55.1 percent) of which is corporate headquarter or multitenant R&D space.

Additionally, approximately 895,000 square feet has been delivered year-to-date.

Industrial vacancy

At mid-year, the vacancy rate for industrial space dropped to 6.8 percent, compared to 7.3 percent at the end of last quarter and 7.7 percent the same time last year.

East County had the lowest vacancy rate at 1.9 percent, while North County registered the highest rate of 7.7 percent.

Countywide net absorption levels were strong with approximately 1.2 million square feet for the quarter, bringing the year-to-date figure above 1.9 million square feet. Central County had the largest gain with approximately 710,000 square feet of net absorption for the quarter.

Industrial lease rates

The average asking lease rate for all types of industrial space in San Diego County increased during the quarter from 97 cents to 99 cents.

This represents the second consecutive quarterly increase in asking lease rates after four quarters of zero growth. The highest average asking lease rate was Torrey Pines with a rate of $2.45. By contrast, the lowest average asking lease rates were recorded in East County and Otay Mesa at 52 cents and 54 cents, respectively.

Industrial construction

Construction activity for industrial and R&D space accelerated during the year.

Currently, there is more than 3.1 million square feet under construction in San Diego County. Of this space, approximately 1 million square feet (31.2 percent) is being developed on a build-to-suit basis.

Oceanside is seeing the bulk of the activity primarily due to a 500,000-square-foot build-to-suit for Biogen Idec (Nasdaq: BIIB).

Other significant projects under way include a three building, 364,000-square-foot build-to-suit for Biogen Idec in UTC, a 353,000-square-foot build-to-suit for Biosite (Nasdaq: BSTE) in Sorrento Mesa and a four-building, 226,000-square-foot build-to-suit for Northrop Grumman (NYSE: NOC) in Kearny Mesa.

Industrial outlook

The most recent report by Torto Wheaton Research suggests "industrial employment is expected to grow 1 percent per year over the next two years -- but despite this growth, employment is not expected to hit previous peaks.

Net absorption for traditional industrial space is expected to witness modest growth over the next couple of years while rental rates are forecasted to decline by 6.9 percent in 2005.

However, San Diego's industrial market also includes a high concentration of R&D space (31.7 percent). Because of this, the health of the industrial market is largely dictated by the success of industries such as wireless communications, medical equipment, biotechnology and aerospace components.

During the next few years, these industries are expected to benefit from strengthening domestic investment, combined with a weaker dollar and improving Asian trading partners.

Retail overview

The retail market in San Diego performed exceptionally well over the past few years and the first half of 2004 was no exception.

While vacancy rates in the industrial and office markets were hovering in the 7 percent and 11 percent range during 2002 and 2003, the retail market consistently posted rates in the high 2 percent to low 3 percent range.

At the end of mid-year, the county's vacancy rate was 2.4 percent, which represented the seventh quarterly decline during the past 10 quarters.

Consequently, San Diego's retail market posted positive net absorption gains for the quarter as well as a modest lease rate increase.

Additionally, due to the low vacancy and continued demand, development activity was strong during the first quarter with more than 1.3 million square feet under construction.

Retail vacancy

At the end of mid-year, San Diego's vacancy rate for retail space dropped to 2.4 percent compared to 2.5 percent at the end of the first quarter and 3.1 percent at the same time last year.

The highest vacancy rate was 8 percent in the Mid City/El Cajon submarket while the lowest rate was in the downtown and Mission Valley submarkets, both at 0 percent.

Net absorption remained solid for the quarter posting more than 300,000 square feet, bringing the year-to-date total to approximately 397,632 square feet.

Retail lease rates

Over the past two quarters, the average asking lease rate appreciated by nearly 5.2 percent from $1.75 to $1.84.

Average asking lease rates for retail space have been extremely stable during the past 12 months, increasing by a modest $0.07 since the mid-year 2003.

The submarket with the highest rate was Golden Triangle at $2.97, while the submarket with the lowest rate was El Cajon and Lemon Grove/Spring Valley/Rancho San Diego, both at $1.26.

Retail construction

Retail construction remained active during the quarter as nearly 1.3 million square feet is currently under construction, the bulk of which (56.3 percent) is located in the Temecula/Murietta submarket.

Other submarkets with new development activity are Chula Vista/Bonita (18.1 percent), Imperial Beach/South San Diego (14.1 percent), Carlsbad/La Costa (7.0 percent) and Downtown/Hillcrest/Old Town (4.5 percent).

Additionally, second quarter completions totaled approximately 375,000 square feet, 261,000 square feet of which occurred in the San Marcos submarket.

Retail outlook

During the next six to 12 months, demand for retail space is expected to stay strong. This will continue to produce low vacancy rates throughout the county as well as modest net absorption gains during the remainder of 2004. Asking lease rates should also remain steady, increasing in selective submarkets.

The investment market is also expected to also remain strong during the remainder of the year.

In fact, the most recent report by PriceWaterhouseCoopers suggests, "the frenzy to acquire strip shopping centers, particularly those anchored by leading grocery stores, hasn't shown any signs of slowing down. Grocery-anchored centers remain the little darlings of the industry. Even though such strong investment demand continues to push up sale prices for the best assets."

Baragona is the senior information management coordinator for CB Richard Ellis.

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