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Report: Improvement far off for top S.D. office markets

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It hasn't been an easy year for the office markets of Del Mar Heights, Sorrento Mesa, University Towne Centre and Governor Park -- and Cushman & Wakefield expects more of the same in 2010.

Del Mar Heights

Del Mar Heights was strong in the mid- to late 1990s before getting hammered when Peregrine Systems bailed out of about 500,000 square feet at the start of the decade.

The submarket rebounded strongly in the middle of this decade when tenants such as major law firms and health care entities re-filled hundreds of thousands of square feet.

When this latest recession hit, space was dumped back onto the market once more.

C&W said the good news is Del Mar Heights posted positive absorption of 5,344 square feet instead of a negative number in the third quarter.

The bad news is there was year-to-date negative absorption of 40,667 square feet and the overall vacancy was still 23.4 percent.

The report says retaining tenants continues to be a problem in Del Mar Heights and when they do move into a space, they are generally vacating another within the same submarket.

Sublease space remains a major part of the story in Del Mar Heights.

Companies actively marketing sublease space in the submarket include Hewlett Packard (NYSE: HPQ), 117,948 square feet; and Avent, 23,663 square feet. Both of these are at Kilroy Del Mar.

Kilroy Realty (NYSE: KRC) has more than 5 million square feet of office and industrial space in San Diego County -- about 1 million square feet of which is empty.

"The Del Mar Heights submarket has taken the largest hit among the Mid-City markets as it relates to the decrease in rates (the area had $4 rents as recently as three years ago) and increase in vacancy, compared to historical numbers," the report continued.

The $2.57-per-square-foot full service rent (net of electricity) was the lowest rent since 2003's third quarter.

C&W reports Del Mar Heights landlords don't only have to compete with other landlords in their market, they must also compete with UTC.

The Irvine Co., which owns the 800,000-square-foot Plaza at La Jolla Village among other properties here, has been aggressive with its rents in a full-court press to fill its own buildings.

University Towne Centre

The UTC submarket posted 25,727 square feet of negative absorption in the third quarter and gave back some 257,634 square feet through the first nine months of the year.

UTC is another submarket that has been acutely affected by boom-and-bust cycles.

It got so bad after overbuilding in the early 1990s that landlords offered as much as two years' free rent on five-year lease transactions.

In the late 1990s, UTC became one of the stronger submarkets in the county, but was hurt again early in this decade with the dot-com bust hitting just as new buildings came online.

UTC had largely recovered by the time recession hit last year but its fortunes have fallen since.

C&W said UTC finished the third quarter at a 27 percent overall vacancy, with direct vacancy accounting for 21.8 percent of that figure.

Hines' 300,000-square-foot La Jolla Commons building may have a Leadership in Energy & Environmental Design Gold certification from the U.S. Green Building Council, but getting it past half full has been difficult -- making servicing any debt particularly challenging.

"We have historically low interest rates and the remainder of the year will be a time for those higher-end projects such as La Jolla Commons to find themselves coming down to a more level playing field as many landlords chase the aggressive rates The Irvine Co. has set as a standard," the report added.

C&W said 2010 will be a time of stabilization for the UTC market and the largest transaction there was an 11,469-square-foot lease with the Covance biotechnology firm.

The report noted the defense firm Kratos (35,000 square feet), Covance (40,000 square feet) Scripps Health (14,000 square feet) IBM (13,000 square feet) and the private equity firm Wedbush (10,000 square feet) are each looking for space in the marketplace.

Governor Park

The neighboring Governor Park submarket is another area plagued with high direct and overall office vacancies.

The direct vacancy decreased somewhat 21.1 percent to 20.4 percent but that means that more than a fifth of the direct space is still empty.

If sublease space is added into the mix, Governor Park's overall vacancy reaches 29.2 percent.

C&W said The Irvine Co.'s lower UTC rates are impacting Governor Park.

Further, the danger in the Governor Park market is competing landlords will continue to drive down rates from not only UTC, but also from as far away as Kearny Mesa and Mission Valley.

Sorrento Mesa

Sorrento Mesa, which gave back 35,621 square feet of office space in the third quarter, is another one of those submarkets where sublease space is a major factor.

Semiconductor firm Conexant Systems (Nasdaq: CNXT) is marketing slightly less than 200,000 square feet and the state Compensation Fund is subleasing more than 25,000 square feet in the Sorrento Mesa submarket.

Sorrento Mesa had a 11.7 percent direct vacancy as of the end of the third quarter. While this isn't a particularly high figure, the vacancy climbs to 17.1 percent if sublease space is included.

The Sorrento Mesa submarket had zero lease transactions that were 10,000 square feet or more but there are companies looking.

The largest of these is American Specialty Health, which hopes to find 200,000 square feet in Sorrento Mesa. URS, (NYSE: URS) a planning and engineering firm; general contractor T.B. Pennick & Sons; Samsung; PricewaterhouseCoopers; and The Boss Law Firm are each looking for spaces that are between 10,000 and 35,000 square feet.

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