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Weakest in a decade

County office market took hits in mid-2008

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Two reports on San Diego County's office market seem to confirm what many have already concluded: the current situation is the weakest in more than a decade, and timing a rebound has become a dubious science.

"The current environment is different because the wave of vacancies occurring the last half of 2008 was due to the complete closure of many businesses not able to survive the current recession, Colliers International reports. "These companies are not downsizing which would increase sublease activity -- they have just gone out-of-business -- resulting in vacant space going back to building owners."

The Studley commercial brokerage firm arrived at a similar conclusion.

"The rapid deterioration in the last few months has pushed more businesses into a bunker mentality. Most firms are avoiding major expenditures such as long-term space decisions," Studley added.

Studley said the market is so soft that even firms needing short-term space find themselves in a strong bargaining position.

"And those with the ability to commit to space for the long term can lock in solid discounts," Studley wrote. "Landlords are more concerned than ever with securing cash flow and continue to increase the size of concession packages. As sublet supply continues to increase, landlords are feeling even more pressure to lower face rents."

Colliers, which noted that most of 2008's negative absorption occurred during the last quarter of the year, said the loss of thousands of jobs in the financial services and real estate industries in the county last year, had a direct impact on the need for space.

"Absorption was positive through the first three quarter of 2008 but suffered a 712,727-square-foot loss in the fourth quarter alone: the worst quarter for office on record.

"This brought year-to-date net absorption to minus 697,416 square feet -- eroding the minor positive activity that occurred in the first nine months of 2008," Colliers continued.

Even though new supply (defined as construction completed in 2008) significantly contributed to the direct vacancy increase, Colliers said pre-existing buildings gave back 1.8 million square feet to the market.

Colliers pegged the countywide office vacancy at 17.1 percent at year-end.

By that firm's accounts, the office vacancy that increased by 3.7 percent during the last year alone, had been 8.9 percent as recently as the second quarter of 2006.

Studley placed the countywide office vacancy at 15.7 percent. That firm said the vacancy was up by 3.5 percent in 2008.

Studley concludes that the serious deterioration in the national economy could delay a regional recovery, noting that many industries here that were holding up quite well earlier in 2008 were struggling as the year ended due to the credit crunch and the severe contraction in spending that followed.

"The tech sector, a critical component of the San Diego region's economy, for example, has started to lose revenues and cut jobs. Midway Games (NYSE: MMY), for instance, recently announced that it would let go 180 employees and firms such as Agilysys, Inc. (Nasdaq: AGYS) have been cutting payrolls since the summer," Studley wrote.

But, all the news isn't bad.

Chad Urie, a Colliers senior vice president, said there are some bright spots in this otherwise dismal economy.

"It is likely that the sublease vacancy rate will increase during the next few quarters as some businesses downsize. But sublease space tends to offer move in ready solutions along with lower lease rates -- a boon for tenants looking for space that is affordable, " Urie stated.

Urie added that tenants who occupy more than 60,000 square feet are finding they may now be able to relocate to space that was unaffordable before.

"And if a landlord uncovers an opportunity to fill a significant vacancy in their portfolio, they are going to pounce, " Urie said.

Studley noted the leasing market is showing some tentative signs of improvement, with several firms signing long-term deals in prime Class A properties.

While there are very few counter-cyclical industries in this downturn, the education and healthcare sectors have sustained some growth.

During the quarter, Bridgepoint Education (which also has a large newly signed lease in Sabre Springs) signed an 11-year deal for 250,000 square feet at Sunroad Centrum in Kearny Mesa. The company will occupy the new property in two phases beginning in March.

Healthcare firm Kaiser Permanente, the nation's largest not-for-profit health plan, also recently inked a deal for 31,108 square feet at 17140 Bernardo Center Drive in Rancho Bernardo.

There is other good news. Colliers said while 1.4 million square feet of new office space is currently under construction in the county (more than 3 million was underway a year ago) little, if any of the planned 13.4 million square feet of additional planned office space will be coming out of the ground anytime soon.

That will give overbuilt submarkets such as Carlsbad and the Interstate 15 Corridor, a chance to lease up.

"Closing the office construction pipeline will provide some relief to a (countywide) market that has experienced an eight-year trend of over-supply," Colliers concluded.

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