Office Rents at Historic High

Economy fuels demand

By David Marino

2014 ended as the strongest commercial real estate market since 2006. In the San Diego County region, 5.7 million square feet of office, lab and industrial space came off the market on a net basis.

Just to put that in perspective, that would be as if all the office space in UTC was vacant at the beginning of the year, and was fully leased by the end of the year.

We are particularly seeing supply shortages around the region in large blocks of space over 50,000 square feet. Certain submarkets have become particularly tight for larger tenants including full-floor tenants in UTC, warehouse and distribution tenants above 30,000 square feet in Miramar, and Class A space around the region. For example, there is not a single space over 45,000 square feet in Del Mar Heights today.

Class A rental rates in both UTC and Del Mar Heights are back at nearly record historic highs over $4 per square foot. One new building under construction in Del Mar Heights has a $4.95 net of electricity asking rate, and the tightness in the market might support it.

The only time in history we have seen these high rental rates was briefly back in 2006 and 2007 during the economic bubble, and there are no signs of any bubble today. We are dealing with rapidly shifting dynamics of supply and demand, with demand accelerating and supply essentially frozen due to the lack of new construction.

It’s a similar story in Downtown, with no new office tower developments on the immediate horizon. Class A office towers are over 95 percent leased across the board (with a few exceptions) — and Class B is slowly starting to creep up. Rents for a few Class A office spaces have jumped an astonishing 50 percebt in the last 24 months. Fortunately, there are still a few landlords in tough occupancy shape, thereby keeping rents from skyrocketing across the board.

Of the more than 300 transactions we are actively engaged with, virtually all of them are with healthy companies, and many of them are significant expansions for clients coming to the end of their lease terms.

More telling, dozens of companies are seeking mid-term expansions on leases that were signed two or three years ago because they are already out of space. This is due to the exceptional health of the companies’ top lines as well as the strength of the capital markets fueling growth and employment.

The total amount of sublease space available in the region is also at a near record low at 3.3 million square feet. Tenants that used to be able to get cheap, fully furnished space are finding it in very short supply, and are often left without any good options.

Additionally, showing to the strength of the market and economy, the average time on the market for office space is now below 18 months in every submarket except Del Mar Heights and Downtown. UTC is under a year, which has never before been the case, and we are seeing competition for larger blocks of space in quality buildings.

The biotech lab market has significantly recovered in the last year as approximately nine life science companies went public in 2014, fueling the consumption of additional lab space.

Multiple life science companies are poised to go public again in 2015, which will continue to drive significant growth and demand for lab space in Torrey Pines, UTC and Sorrento Mesa. All of this is putting pressure on lab rents as space becomes in shorter supply. Torrey Pines rent numbers have recovered back to above $3 per square foot, and there is a particular shortage of supply for smaller startup companies below 10,000 square feet seeking existing lab space.

Going forward, we expect to see continued upward pressure on rents as the economy fuels demand, and the supply of new space is effectively non-existent as speculative construction will not happen fast enough to support the increase in demand.

This is particularly true in industrial space where demand is strong, but land prices for the available vacant sites in San Diego County are too high to justify putting industrial buildings on them. The price of land is simply too valuable, so we don’t expect significant industrial space to be built ever again except in certain markets like Otay Mesa, San Marcos and Vista.

 

 

 

 

David Marino is executive vice president of Hughes Marino, a San Diego commercial real estate company specializing in San Diego tenant representation and building purchases.