The Summit in Rancho Bernardo is beginning its first 40,000-square-foot phase of a projected 3.2 million square feet. The $1.2 billion project will have 11 office towers. Jay Paul Co. is the developer.

San Diego County’s commercial real estate markets are remarkably stable. Despite slowing job growth — down from 19,000 in 2006 to 16,000 in 2007 — and a local economy reeling from the loss of about 5,000 jobs in real estate construction, the diversified employment base is obviously the prime factor in propping up the commercial sector, despite a residential sector that is perhaps approaching its lowest point in 15 years.

Is a cloud hanging over the horizon? If so, it is just to the north, over Orange County where the MacArthur Boulevard corridor, which housed the home offices and centers of some of the largest mortgage lenders in the nation, is now reeling with vacancies. San Diego’s commercial markets, given the smaller nature of the businesses here, are not likely to face the same dilemma. This is why diversification matters.

The other pundits tend to focus on the residential sectors as driving the economy. In truth, most economists and federal regulators are more focused on the energy sector, as higher gas prices drive up all prices, stir inflation and limit consumer spending in real time.

With that said, we enter another year of uncertainty, and for good reason:

• Capital has become elusive for most new projects, although the cost of money is low. Most of the capital, and there is lots of it, is on the sidelines, unwilling to commit until there is more of a sense that pricing across the board for real estate assets has bottomed.
  
  
• Consumer spending is driving retail sales, which, in turn, is pushing occupancies and lease rates upward. Stay tuned on this front, particularly if energy prices continue to escalate.
  
  
• The industrial sector remains strong in this county as space for manufacturing and warehousing becomes even more precious in a coastal market that views it mostly as an underutilization of land use. Otay Mesa and North County are adding most of it.
  
  
• The apartment sector is very strong and valuable, as rental rates will rise and occupancies will stay exceptionally low as those previously prospective first-time homeowners remain renters for the foreseeable future, competing for housing with those “millenniums” (Gen Y) now flooding into adulthood. Adding inventory will be a long, slow process.
  
  
• The drop in housing activity and valuation declines is still playing out, and the sector will take most of 2008 to sort out.

Have 6 Million Square Feet/Need Tenants

With little to no office employment growth in San Diego County in 2007, the office market in 2008 will begin to slow down as it waits for newly constructed space to be absorbed and for rent rates to level off. Over the past three years, vacancy rates have increased from about 8.7 percent to 10.5 percent and average annual rental rates have bumped up from $28.42 to $30.69 per square foot. With more than 3 million square feet of office space constructed in 2007, and more than 3 million square feet currently under construction and expected to be delivered this year, we may find the market oversupplied and vacancy rates rising.

Nearly 2.3 million square feet of space was absorbed in 2007, which almost doubles the absorption of the previous year, and more is being built throughout San Diego County. Of the current office projects proposed or under construction, most will be developed in areas away from Downtown, Kearny Mesa and UTC. Of the 209 projects proposed or under construction, 21 percent are located in Carlsbad, 20 percent in San Marcos/Vista, 10 percent in Oceanside, 10 percent in South San Diego, 9 percent in East County and the remaining construction in other areas of the county. Downtown accounts for 1 percent, Kearny Mesa 4 percent and UTC 1 percent.

Of the largest projects, those 100,000 square feet or more, 41 are under construction or proposed in San Diego County. Of these projects, Rancho Bernardo/Poway accounts for 29 percent, Sorrento Mesa 17 percent, Kearny Mesa 15 percent and Scripps Ranch 12 percent.

The most interesting opening of 2008 will be The Summit, a former industrial/technology campus in Rancho Bernardo, which is beginning its first 40,000-square-foot phase of a projected 3.2 million square feet. It has something in common with two of the more notable projects that opened last year, Liberty Station (109,000 square feet) and Sunroad Spectrum II & III (400,000 & 350,000).

Each of these projects are adaptive reuses of infill sites. They foretell the future of most all development and redevelopment throughout San Diego County.

Retail Vacancies To Rise

While vacancy rates hovered near 2.9 percent, the decade’s lowest point, the retail market in 2008 will continue to be successful as new retail space is built and absorbed throughout the county. As vacancy rates declined from an already low 3.3 percent, average annual rents rose from $21.73 to $24.54 per square foot. About 1 million square feet of retail space was added in the county last year, and the market absorbed (e.g. rented) nearly 1.5 million square feet.

An extreme decline in the amount of new retail space will be the story of the 2008 market. In the last quarter of 2007, about 650,000 square feet was added. It will be followed by another 350,000 this year. This additional space will increase vacancy rates, especially where it is being built, including San Marcos/Vista, South San Diego, Oceanside, Downtown and East County.

Rents Will Fall In Industrial

The San Diego County industrial market vacancy rate rose to 6.1 percent in 2007, up from 5.5 percent in 2006. About 1.5 million square feet of industrial space was built within San Diego County and approximately 300,000 square feet was absorbed over the past year. Of the 45 industrial projects under construction in San Diego County, the majority are in two markets: Oceanside (50 percent) and Otay Mesa (39 percent). Nearly 4 million square feet of industrial is planned within the county, with about half not yet leased. If all these projects are built this year, vacancy rates will continue to increase and average rents decline.

Preparing For Uneven Markets

The market outlook is the most uneven in recent memory. For-sale residential has true weaknesses, while rental has true strengths. The commercial sectors are strong, but generally slowing. Global and national economic forces will be a major factor for San Diego’s market over the coming year, as worries of recession persist.

Whatever you label it, this is not the robust economy we have enjoyed for most of this decade. The best strategy is to stay conservative in your approach. If you are an investor, there will undoubtedly be opportunities. If you are an owner of commercial and investment properties, this is a good year to manage with extra care.

Gary H. London is president of The London Group Realty Advisors Inc., providing real estate consulting and economic analysis. Check him out on the Web at www.londongroup.com or e-mail him at glondon@sandiegometro.com.