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Office leasing continues slow pace in 2009

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The San Diego County office market remains a tenants' market with rising vacancy and declining rents, a recently released first-quarter Cushman & Wakefield report shows.

According to the study, first-quarter 2009 countywide direct office vacancy stands at 15.3 percent, up from 12.3 percent the same time in 2008. Direct asking rental rates are averaging $2.55 per square foot countywide, down from $2.73 per square foot as of March 31, 2008.

Cushman & Wakefield projects that 2009 leasing activity will remain under the levels of the past 10 years as companies continue to feel the effects of the national recession. Additionally, effective rental rates for San Diego office space will continue to decline until employment growth resumes and confidence in the general economy strengthens.

"All industry sectors are focused on reducing expenses and as a result we are seeing firms opting to sublease unwanted space or restructure existing leases in an effort to downsize and leverage rapidly declining rental rates," said Brunson Howard, an office specialist with Cushman & Wakefield's San Diego office.

The study shows vacancy rates increased most dramatically in those San Diego County submarkets with new speculative product.

Several of the large lease transactions in the first quarter occurred in Class A buildings such as La Jolla Commons and Kilroy Sabre Springs.

"While most tenants are adopting a conservative approach to their office space needs, some firms are still willing to pay a relative premium for image and location, and are taking advantage of significantly lower lease rates and robust concessions," Howard said.

Notable first-quarter leases included a 28,710-square-foot lease by KPMG LLP at La Jolla Commons, a 24,000-square-foot lease by Volcano at Kilroy's 3661 Valley Centre Dr. in Del Mar Heights, and a 23,382-square-foot lease by Division of the State Architects at The Pinnacle in Rancho Bernardo.

Following a positive fourth-quarter 2008, where absorption totaled 29,400 square feet, the first quarter of 2009 posted negative direct absorption of 548,761 square feet. This compares to a negative 318,891 square feet of direct absorption in the first quarter of 2008, the study shows.

Howard noted there are far fewer direct transactions occurring, and that much of the negative absorption is due to tenants of all sizes contracting, or leaving direct space for sublease opportunities that offer extremely low rates, flexible terms and in many cases full furniture, fixtures and equipment.

"Tenants continue to take advantage of moving allowances and considerable leasing incentives being offered through unconventional deal structures," he said. "This includes rent abatement or very aggressive start rates that escalate in larger fixed increments over an annualized basis."

The slowdown in tenant growth and activity has had direct impact on rental rates countywide as well as in the traditional high-demand, upscale submarkets such as Del Mar Heights and UTC. Cushman & Wakefield reports that asking rental rates in Del Mar Heights -- where just over a year ago rates were topping $4 per square foot -- have declined by as much as 10 percent.

Marc Posthumus, also with Cushman & Wakefield, noted that one growing bright spot is the I-15 corridor, which is leading the county with 46,868 square feet of positive net absorption as of March 31. All of this activity was recorded in Rancho Bernardo and Sabre Springs.

In Rancho Bernardo, The Division of the State Architects signed a 23,382-square-foot lease for a full floor in The Pinnacle, which continues to attract tenants with aggressive rent packages. In Sabre Springs, Bridgepoint continues its aggressive expansion by leasing the top floor of Kilroy Sabre Springs (17,259 square feet). This, coupled with Hospira's expansion into an additional 22,454 square feet also in Kilroy Sabre Springs, has contributed to Sabre Springs' declining vacancy, which stood at just 6.1 percent for direct space as of March 31.

The I-15 corridor also leads the region in new construction with 906,734 square feet of the 1.5 million square feet underway countywide. Projects under construction include The Summit at Rancho Bernardo, with approximately 200,000 square feet scheduled to be completed in the second quarter 2009; Sony's 450,000-square-foot, 11-story headquarters in Rancho Bernardo, scheduled for completion in June 2009; and the second of three 110,000-square-foot buildings at Bernardo Terrace Corporate Center (the building has broken ground but construction is on-hold for the near-term). Bernardo Terrace's first building, which completed in 2008, is currently available for lease and close to achieving its LEED certification.

"Developers are now not only focusing on style and amenities but sustainability," said Posthumus. "This is important as tenants are increasingly environmentally conscious and also value energy and water cost savings."

Posthumus added that while the 2009 outlook for the San Diego County office market may be cautious, the long-term prognosis reflects opportunity. "Once capital begins to flow into the corporate sector, businesses will begin to expand again, creating renewed demand for space."

"San Diego is well-positioned to recover quickly with the next economic upturn, given the strength and diversity of our core industries and trademark high quality of life," Howard said. "It is during challenging economic cycles that we truly see the persistence and innovation of San Diego's entrepreneurial base through new startups and reincarnations of existing companies. When the economy recovers, these companies will begin to grow and expand, creating consistent demand for office space across the county."

Grove is president of The Grove Agency.

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