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Industrial vacancy to continue below 8 percent through 2008

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A recently released outlook report for 2008 by Cushman & Wakefield shows the San Diego County industrial market continues to perform well, with healthy supply and demand balance despite current volatility in the housing and financial markets.

"We anticipate slight increases in vacancy due to continued contraction in the residential construction and home improvement sectors as well as fewer corporate expansions," said Mickey Morera, senior director with Cushman & Wakefield's San Diego office. "However, our forecast calls for industrial vacancy to stay below 8 percent on total inventory -- a position it has held for the better part of a decade."

According to the report, the San Diego County industrial market historically has enjoyed tremendous stability. Since 1995, single-digit vacancy has prevailed year-after-year with the exception of 1999, when the rate jumped to 13.5 percent following the addition of more than 13.7 million square feet of space in just 24 months. From 2000 through 2007, total countywide net absorption of 17.3 million square feet actually exceeded the 16.8 million square feet of new space that entered the market during the same period.

The Cushman & Wakefield Outlook shows that the strength of the San Diego County industrial market is supported by continued demand for manufacturing and warehouse space, which is increasingly hard to find in the coastal and central county areas. As a result, the northern and southern regions of the county, where more land is available at more affordable prices, continue to lead the region in new construction.

"We anticipate that these markets will see the greatest impact on vacancy as space completed last year and this year takes time to absorb," Morera said.

The report shows that because industrial product is consistently one of the county's most stable commercial real estate product types, small for-sale buildings and condominiums continue to gain popularity.

"Increasingly savvy small business owners recognize that by investing in their business location, they will realize the tax benefits of ownership, future property appreciation and the ability in the near-term to control their occupancy costs rather than face escalating rental rate increases," Morera said.

San Diego County net industrial absorption in 2007 totaled 840,287 square feet, most of which occurred in the fourth quarter. This is up from 2006, when just 487,000 square feet of net activity occurred. Gross tenant activity, which includes user sales as well as all leases signed including subleases and renewals, was 1.4 million square feet for the fourth quarter of 2007 and 8.6 million square feet for the year.

The countywide industrial vacancy rate stands at 8.4 percent based on leasable inventory and just 6.7 percent on total inventory, including owner-user product. Most of the mid-county markets report vacancy well below 5 percent, a figure not expected to change in 2008, with little or no space being added to those areas.

While demand for industrial space is steady overall, the county's low overall vacancy rate reflects the fact that there is not a lot of available product to choose from in most submarkets. This is particularly true of the popular and well-established mid-county markets including Kearny Mesa, Miramar and Sorrento Mesa/Sorrento Valley.

"We anticipate demand for industrial product to continue to be dominated by local technology companies who require storage and manufacturing space, defense companies and retailers whose inventories will rise and require more warehouse space due to slower retail sales," Morera said. "Other active tenants will include freight/transportation, moving/storage, health care, local government and food and beverage services."

"The tight supply in these central markets and limited availability and high cost of land for development continues to drive new construction to the northern and southern regions of the county," he said. The report shows that in 2007, South Bay accounted for 50.3 percent of the 2.6 million square feet of new industrial space completed countywide, while North County accounted for another 38.9 percent including owner-user space.

According to Tucker Hohenstein, senior director with Cushman & Wakefield's Carlsbad office, the majority of new construction in North County is small for-sale-only product.

"This will result in higher vacancy rates in the short-term," Hohenstein said. "In the long-term, however, larger industrial space should do well as this final development cycle is completed, and high land and construction costs will not justify the development of big facilities."

San Diego County industrial construction is slowing -- with 416,000 square feet of space under way at year-end 2007 compared to 1.7 million square feet at the same time a year ago.

"This is good news for the north and south county markets that will use the break in activity to absorb new inventory," Morera said. The report shows average countywide asking rents of 87 cents per square foot triple net, compared to 83 cents per square foot one year ago. Mid-county asking rates for warehouse distribution space range between 78 to 85 cents per square foot triple net, followed by North County with rates averaging 65 to 72 cents per square foot, and South Bay where rates range from 58 to 65 cents per square foot triple net.

"While countywide asking rents are expected to hold steady this year, the South Bay and North County markets will see a trend toward 'free rent' concessions as owners compete to lease their available inventory," Morera said.

Carmel Mountain Ranch reports the county's highest industrial vacancy rate at 17.2 percent, followed by Otay Mesa with 16.7 percent vacancy and Oceanside with 13.1 percent vacancy. In Oceanside and Otay Mesa, vacancy will continue to increase due to new space scheduled to complete this year: 149,000 square feet and 261,600 square feet, respectively.

According to Cushman & Wakefield, the San Diego County R&D market is seeing moderate activity with declining demand for space particularly in the space range of 40,000 to 60,000 square feet.

"The majority of current tenant activity is taking place in spaces under 25,000 square feet and over 100,000 square feet," said Eric Northbrook, senior director with Cushman & Wakefield. "Corporate users will continue to be cautious with their expansion plans and must have an immediate business need for space in order to relocate or expand."

Northbrook added that owners of R&D buildings are well positioned, particularly during a time of cultural change and fiscal belt-tightening.

"As corporate America continues to focus on space cost per employee, the flexible structure of R&D product is more appealing from an efficiency standpoint, making it convenient for companies to modify work environments to meet changing business requirements," he said. "It also embraces the trend toward open work environments and accommodates and encourages the use of demountable wall partitions, which are becoming more prevalent."

Defense, government and wireless communications companies are active in the market, according to the report. Major users expected to complete transactions in 2008 include: Giant Leap Wireless, which is seeking approximately 150,000 to 200,000 square feet; the General Services Administration (GSA), which has a 250,000-square-foot requirement; Sony Online, 150,000 to 200,000 square feet; and defense contractor Lockheed Martin, which needs to consolidate into up to 150,000 square feet.

Grove is president of The Grove Agency.

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