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Class B office space in county still slow to absorb

Reports by Colliers International and Jones Lang LaSalle say while there was respectable office space absorption in the first quarter of 2012, Class B space absorption was still slow.

By Colliers' accounts, with slightly more than 275,000 square feet of net absorption in the first three months of the year, the rate was on par with the roughly 280,000-square-foot average from three of the last four quarters.

Jones Lang LaSalle (NYSE: JLL) reported modest negative absorption of 57,000 square feet. Differences in surveys may be attributable to a wide range of factors, including the minimum size of the office buildings included, whether leased but vacant space is considered occupied, and the survey's timing.

While Class C — the cheapest space — absorbed 107,590 square feet, Class B space only managed an anemic 13,583 square feet of net absorption according to Colliers. The picture is even worse by Jones Lang LaSalle's accounts. The global brokerage firm reported a total of 185,000 square feet of Class B office space was returned to the market in the first quarter of 2012.

Class A space continued to thrive — at least by Colliers' accounts — with 154,413 square feet of net absorption countywide as the flight to quality continues.

Downtown San Diego posted 20,101 square feet of net absorption in the first quarter according to Colliers. It's not a very impressive figure given the submarket still has about 2 million square feet left to fill. Both Class B and C office space posted modest positive absorption of 30,515 and 31,914 square feet, respectively, downtown.

Colliers reported the overall countywide vacancy decreased by nearly 40 basis points to 15.0 percent in the first quarter. That translates to 14.2 direct vacancy and the remainder for sublease space. Jones Lang LaSalle pegged the first quarter direct vacancy rate at 15.8 percent — down from a peak vacancy of 17.3 percent two years ago.

"The past two years each have seen over 1 million square feet of net absorption and 2012 should prove to be comparable or better. However, demand during the past two years was comprised primarily of larger tenants that took advantage of a tenant’s market in which to relocate or expand," Colliers writes.

Both reports agree there has been a flight to quality as tenants seek bargains on Class A space, but that door may be closing. As suggested by Jones Lang LaSalle, tenants may be pushed back into the Class B spaces as rents rise for the most desired spaces.

The Irvine Co., for example, has just raised its rents in the University Town Centre area by 25 to 50 cents per square foot. The office and apartment property mogul has also raised office rents to a somewhat lesser degree in Mission Valley.

Although rents are already climbing in certain particularly Class A properties, Scot Ginsburg, managing director at Jones Lang LaSalle, said, "Class B office tenants still have 12-18 months of great opportunities. Rents are in the mid-$1-per-square-foot range — still 25-35 percent off their peak."

"Early signs in 2012 are pointing to more active small- to mid-sized company startups and expansions. This steady demand throughout 2012 will likely improve the year-end 2012 total vacancy to the 13.0 to 13.5 percent range with sublease vacancy continuing to remain under 1 percent," Colliers writes.

Colliers reports overall suburban office market and CBD market vacancy rates were 14.3 percent and 20.0 percent respectively. The suburban submarkets of Scripps Ranch (35.3 percent), South Bay (25.1 percent), Carlsbad (22.8 percent) and Miramar (22.7 percent) continue to maintain the highest vacancy rates in the county. Countywide Class A vacancy decreased by 48 basis points in the first quarter bringing the rate to 13.6 percent. Additionally, both Class B (17.9 percent) and Class C (12.1 percent) vacancy rates declined in the fourth quarter.

Although there is still a great deal of space in many submarkets, large contiguous ones are few and far between. This has led companies such as Linsco Private Ledger to build their own office space. As noted by JLL, Linsco is developing a 406,000-square-foot La Jolla Commons II office building at 4700 Executive Drive in the University Towne Centre area.

Other construction cited by JLL includes a 50,896-square-foot renewal/expansion for Sharp Healthcare in Scripps Ranch; a 45,655-square-foot renewal/expansion for FutureWei Technologies; and a 20,000-square-foot space for the law firm of Morris Sullivan & Lemkul, LLP.

Not all tenants are expanding. JLL noted that Del Mar Heights-based Cadence Pharmaceuticals, for example, is downsizing into a 23,494-square-foot space upon the recent renewal of its lease.

More than 13.7 million square feet of new construction is proposed countywide. The largest proposed project is located in San Marcos near CSUSM and is named “North City.”

Construction is scheduled to begin within the next few months on what is expected to be on approximately 660,000 square feet of office space in three Class A buildings.

"With the exception of this unique project, it will be a few years before we see any major shift toward speculative multi-tenant development," Colliers wrote.

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