As investors continue to purchase San Diego's core office buildings and small businesses are increasingly purchasing office condos for their office space needs, the San Diego office market has become a hot commodity.
Barbara Kreis, a senior vice president with Sperry Van Ness and a board member of Commercial Realtors Association San Diego (CRASD), a real estate association, said the San Diego office market is one of the most sought after markets for investors.
"Looking at the office market at this time, I think it is one segment of the investment market that can provide the value added or opportunistic strategies to enhance the returns component," she said, adding that nearly one-third of all sales in the office market were generated by investors.
She continued, "Last year, value was often created by cap rate compression, but lately, with interest rates on the rise, value has to come from basic fundamentals of increased income potential. And that's where the office segment shines."
The downtown office market, in particular, has experienced significant activity in the last several years.
"This past year, we have seen seven core buildings sell at benchmark prices during a time when downtown leasing has actually been slow," Kreis said. "There seems to be more activity in renewal and movement between buildings than new tenants to the marketplace. Rents, however, are still rising, which is somewhat ironic."
Kreis also noted that with the monopoly of ownership on downtown's Class A office buildings by The Irvine Co., which has raised rental rates by 25 cents to 75 cents per square foot, the trickle-down effect will be felt by all of downtown's office building tenants.
"The rise in Class A building rents offers the opportunity to raise rents in B and C class buildings, thus providing the value-added component based on the fundamental of increased income that investors seek," she said.
While many outside investors, such as The Irvine Co., are turning to the San Diego market, Kreis said that she expects many local investors to target out-of-the-area markets, such as Phoenix, Dallas, Houston and Las Vegas.
Many investors who do choose to stay in San Diego are now looking to office condominium development.
As of late, there has been a big change in converting office and industrial properties into condos, said Eric Thies, president of BRNIKA Inc. and incoming president of CRASD.
"Just as the residential developers are exploring the sustainable absorption rate for residential condos downtown, so too are the commercial developers in seeking out the supply/demand equilibrium for office/industrial condos," Theis said.
However, the likelihood of these buildings being converted into office or industrial condos depends on the availability of SBA loans at reasonable rates, he said.
"Even a modest increase in SBA rates would have an immediate chilling effect on commercial condo absorption levels," Thies said.
Yet, Rich Murdock, SIOR, CCIM, a senior vice president with GVA Commercial, said that with loans and the great tax benefits offered to businesses that purchase office condos, the demand for office condos will likely remain popular.
"Buyers can now afford to end up with an equivalent cost of occupancy to leasing," Murdock said. "If the market is at $1.85 plus utilities, a buyer of an office condo could possibly get in at $1.60 after tax benefits."
With the market for office condos increasing in activity, especially outside of the urban downtown areas, such as Mission Valley and Pacific Beach, Murdock said he anticipates that more developers will bring office condos into the market.
If more property does come into the market, Murdock said that he expects the office market will follow on the heels of the residential market, where sellers are having to wait longer to close a deal.
"More property coming on the market means that we are going to see more creative financing from sellers and more creative concessions from property owners to get people moved in," Murdock said.
Dennis Hearst, CCIM, SIOR, a senior director with Cushman & Wakefield, said one of the most important factors impacting companies when choosing office space is how it will impact their employees.
With a tight labor market, companies want to hold onto their employees, and offering a nice building with nice amenities is one way they can do that.
"What we are seeing is that strong, successful companies feel that they need to offer high-quality work environments, such as larger work areas, nicer buildings, cafeterias, workout facilities and other campus type amenities," Hearst said.
Companies are also looking at where the office space is located in proximity to where the majority of their employees live.
"Traffic issues are causing more companies to conduct commute studies. Now they have to look at where their people live and whether the office is going to be hard for their clients and their employees to get to," Hearst said. "It used to be that if you moved four miles away you would either be adding four minutes more or deducting four minutes less from your commute. Now if you move four miles away, it can make an unpredictable difference."
Kovach is a senior account executive with Whitelaw Marketing Inc.