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Mid-county market faces shrinking land supply, density and spiraling costs

Office and industrial development in the mid-county market has much promise, but the lack of developable land, the politics of density and spiraling construction costs could affect the dynamic.

The mid-county area was defined as generally bounded by Del Mar to the north, Mission Valley to the south, the Interstate 15 freeway to the east and the ocean to the west at a panel presentation by the National Association of Office and Industrial Properties (NAOIP) at the La Jolla Marriott Hotel last month.

Panel moderator Mark Wayne of Burnham Real Estate said the mid-county area accounts for 60 percent of San Diego County's office space, 63 percent of the research and development space and 26 percent of the industrial space in the region. Wayne said the vacancy for office space stands at 8 percent and just 4 percent for R&D and industrial in this zone.

"Three million square feet of new office space is underway, and half of it is spoken for," Wayne reported.

Rents range from $3 to $4 per square foot, with Del Mar Heights and UTC commanding the highest rates. Del Mar Heights, Wayne said, is 99 percent built out with a 5 percent vacancy rate.

Wayne said improvements to the I-5/I-805 merge should help Del Mar Heights, UTC and Sorrento Mesa.

In the meantime, many submarkets are running out of land.

Panelist Paul Twardowski of Hines said with land rapidly disappearing, increased density is the only way to continue the momentum within the commercial real estate sector in San Diego.

"Unless we change densities, growth will be restricted," Twardowski said. "By increasing density, Kearny Mesa could grow over the next five to 10 years."

Without density, he said, you get employment nodes everywhere and traffic throughout the county.

"Density is the key to mitigating traffic over time. The city has an uphill battle with some local groups, but hopefully they won't back down," he added.

"San Diego is geographically land constrained," said panelist Rick Vann of Sunroad Enterprises. "There is no developable land left in mid-county ... We need to re-densify where we have the infrastructure to do it. This will continue to fuel real estate."

Vann's company is responsible for Sunroad Centrum at the San Diego Spectrum on the old General Dynamics site in Kearny Mesa. Centrum will eventually include 1 million square feet of office space. Now under construction, the 300,000-square-foot first phase is slated for completion by June of next year.

"Centrum hasn't changed from its original plan, except instead of being spread over 40 acres, it will now occupy just 10, while the other 30 acres will include residential and other uses," said Vann. "This is possible because of the city of San Diego's new attitude (toward density)."

"Kearny Mesa hasn't seen this type of vertical development before. Are we building higher in the future?" Burnham's Wayne asked.

"Yes, we are going higher. We have to go vertical and use parking structures as land costs rise," Vann replied. "It also helps to underground parking to get a better yield on the land."

Density is also a key component in Hines' La Jolla Commons project in University City. The approximately 350,000-square-foot project will be in 18 stories. That project is slated for completion in the spring of 2008.

The panelists agreed that densities in employment nodes should be increased and that zoning to protect manufacturing uses is a mistake in areas that are largely built out.

"It would be a disaster for the city if they downsize for manufacturing. It's a form of taking to subsidize manufacturing. We aren't a manufacturing town anymore," said panelist David Thomas of LBA Realty Inc. "All Kearny Mesa should be dense."

The panelists also agreed that rising construction costs are the biggest challenge for ground-up development.

"If there is no economic advantage going in, it's very difficult to compete. Our advantage was a good basis on the land. There is not a lot of defense against rising construction costs," said Vann. "You must value engineer down to the minutia."

Twardowski said his firm still has jobs to bid, and the process is getting harder all the time.

"Glass, steel, concrete are all high. It's thrown out of whack how we bid a job," Twardowski said.

Vann added that the eventual slowdown in construction activity may help alleviate construction costs.

"As construction slows, the labor factor will benefit new construction costs because people will be looking for work and labor costs will be more competitive," he said.

"Labor availability may help tenant improvement costs, too," added Twardowski.

Wayne reported that tenant improvement costs are running between $35 and $40 per square foot.

While frustrating some, the cost of tenant improvements has actually helped Thomas' LBA Realty to retain tenants.

"Everyone is struggling with tenant improvement costs, and it's harder for tenants to move," he said. "We retained 75 to 80 percent of our tenants last year. Renewal is a better option for them."

LBA bought the Airgas facility in Kearny Mesa within the past few months.

"They are a good tenant right now, but if they move out, we will eventually make it more dense," Thomas said.

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