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Office market continues to improve

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A just-released study by Burnham Real Estate shows that the San Diego County office market is off to a great start this year, with healthy net absorption and gross leasing activity already being reflected in lower submarket vacancy rates.

According to the Burnham report, the San Diego County office market absorbed 383,249 square feet of space during the three-month period ended March 31, 2005. Given the additional amount of square feet in newly signed leases, the market is on track to absorb nearly 1.8 to 2 million square feet of space in 2005 - this is consistent with the amount of space absorbed in the last three years.

"The region has regained supply and demand balance, which is already being reflected by higher rental rates and fewer concessions in some submarkets," said Mark Wayne, senior vice president with Burnham Real Estate. "Tenants are locking in space commitments now, in part to precede even higher expected rental rates in 2006. Certainly, the diminishing supply of land and available space options is further motivation for tenants to act sooner rather than later."

Most of the first quarter office activity took place in Mission Valley, with 130,000 square feet of net absorption, followed by Sorrento Mesa with 115,000 square feet and the I-15 Corridor with 75,000 square feet. Burnham research shows that this was the third consecutive quarter that Sorrento Mesa absorbed at least 115,000 square feet, and the 345,000 square feet of cumulative activity has helped to notably improve the area's real estate condition.

Much of the quarter's net absorption involved Class A space, and the vacancy rate for this product type now stands at a much improved 10.8 percent. Tenants wanting high-image space before rents spike will generate a flurry of leasing activity later this year, and Class A vacancy could easily fall into the single digits by year-end.

Vacancy rates continued to decline in several suburban office markets during the first quarter. These include Mission Valley, where vacancy fell from 11.6 percent as of December 31, 2004, to 10.9 percent; Kearny Mesa, where vacancy of 8.8 percent is down from 9.5 percent; Del Mar Heights, where vacancy of 11 percent is down from 12.1 percent; Sorrento Mesa, where vacancy improved from 16.9 percent to 16 percent; Torrey Pines, where vacancy dropped to 20.7 percent from 22.9 percent; and North University City (UTC), where vacancy of 11.9 percent is down from 13.1 percent. Much of the net absorption activity involves Class A product, and vacancy in this sector has improved dramatically to its current rate of 10.8 percent. Tenants wanting to lock in high quality space before rents spike will generate a flurry of leasing activity for Class A space later this year, and this should drop vacancy well into the singe digits by year-end.

"With demand on the upswing, speculative construction now accounts for over half of the county's total building activity," said Wayne. "Build-to-suit-to-own product is also substantial, as more tenants recognize the financial operating benefits of owning their own facilities." The Burnham report shows that of the 2.9 million square feet of space currently under way, spec space accounts for 53.8 percent (28 percent of this space is already pre-leased). Build-to-suit-to-own space is next, with 38.5 percent. Build-to-suit to lease space accounts for just 7.8 percent of the current building activity.

"Approximately 1.8 million square feet of the space being built will finish this year," said Wayne. "With net absorption expected to match new supply, overall San Diego County vacancy should fall more than one percentage point to 10 percent by year-end."

Achievable rental rates continue to improve in markets like Del Mar Heights, Sorrento Mesa and UTC. Del Mar Heights shows the greatest improvement, with average monthly rates now at $2.80 per square foot. With the exception of downtown San Diego, rents are expected to continue to increase throughout the county during the latter half of the year.

For more information, visit www.burnhamrealestate.com.

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