Behind the Numbers
- Net absorption of 729,731 square feet (SF) in Q1 2019 was the greatest single quarter of office net absorption since Q2 2006 (+943,408 SF).
- Class A average asking rental rates remained at an all-time peak of $3.33/SF/month, a 2.8% year-over-year increase. Overall average increased by $0.03 to end the quarter at $2.75/SF/month – the highest rate on record.
- Countywide overall vacancy dropped to the lowest level in nearly 14 years (10.2%)
San Diego County net absorption for Q1 2019 equaled 729,731 SF. Class A inventory recorded the most activity with 821,779 SF of net absorption. Class B and C posted negative absorption of 87,418 SF and 4,630 SF, respectively. 529,097 SF of the overall net absorption occurred in new construction completions.
The Carlsbad submarket posted the most positive net absorption (+345,893 SF) in Q1. ViaSat occupied nearly 357,000 SF at its new four building built-to-suit on Town Garden Rd. Additionally, Ezoic occupied 17,510 SF at the newly completed Lift project at 6023 Innovation Way.
UTC (+187,123 SF) and Sorrento Mesa (+117,096 SF) had the second and third highest levels of absorption, respectively. In UTC, Takeda Pharmaceuticals occupied 150,000 SF in the brand-new building at 9625 Towne Centre Dr. In Sorrento Mesa, DexCom occupied 94,293 SF at 5375 Mira Sorrento Pl and Brain Corporation moved into 59,259 SF at 10182 Telesis Ct.
Other notable move-ins included Daylight Solutions (67,792 SF) at 16465 Via Esprillo, DecisionLogic (17,866 SF) at 13500 Evening Creek Dr, and Rogers Behavioral Health (13,489 SF) at 17140 Bernardo Center Dr. These tenants contributed to the 80,634 SF of positive net absorption in Rancho Bernardo.
The countywide vacancy of 10.2% in Q1 2019 is a 26-basis point decrease from the prior quarter. The vacancy rate includes direct vacant space (9.6%) and minimal sublease space (0.6%).
Overall vacancy in Downtown decreased to 12.4% in Q1, driven by positive net absorption of 83,263 SF. Overall vacancy in the Suburban markets dropped to 9.9% with core submarkets such as Kearny Mesa (7.3%) and UTC (7.9%) posting the lowest rates and Carlsbad (18.4%) with the highest rate.
Countywide Class A and Class B vacancy rates ended the quarter at 11.8% and 9.9%, respectively. Class C posted the lowest vacancy rate at 7.5%. Most of the absorption in recent quarters has been attributed to Class A demand, which will continue to force its vacancy to drop faster than the other segments. By year-end, Class A vacancy could conceivably fall below 10% with consideration to the current rate of demand.
New construction completions for the quarter included the 357,000 SF four-building build-to-suit for ViaSat on Town Garden Rd in Carlsbad. Lift – a two-building 54,646 SF development by RAF Pacifica Group – was completed along with 22,097 SF of absorption, also located in Carlsbad. Lastly, a 150,000 SF office building was completed by Alexandria Real Estate Equities and occupied by Takeda Pharmaceuticals at 9625 Towne Centre Dr in UTC. There are currently four projects totaling 511,260 SF under construction countywide, of which 210,994 SF is expected to be completed by year-end. 2019 will have the second highest level of new construction completed in a decade.
The aforementioned projects currently under construction include The Watermark – a 158,994 SF building on Scripps Gateway Court in Scripps Ranch (pre-leased to MedImpact), One Paseo - a two-building 300,266 SF project being developed by Kilroy Realty in Carmel Valley, Sorrento Summit III – a 28,000 SF project pre-leased to Nuvasive and being developed by HCP, Inc., and a 24,000 SF building at 860 S. Coast Highway 101 in Encinitas that will be occupied by ABP Capital.
Rising construction costs, limited developable land, and pre-leasing requirements to secure financing will limit the future development of new office space. However, there has been a trend in renovating existing flex buildings to be fully built-out office space.
Annual net absorption has been consistently strong, outpacing new construction over the last nine years. This is indicative of an office market that is not at risk of being over-built. In fact, 94% of the space completed in Q1 was absorbed and over two-thirds of the space under construction is preleased.
Trends, Forecast & Outlook
Vacancy will continue to decrease throughout 2019, pushing the rate into the mid- to high-9% levels. The current pace of demand for best quality office space will continue to exceed new supply for the balance of this year. Assuming the local economy continues to remain strong and the current supply-demand trend persists, vacancy could drop to its lowest level in 15 years. Additionally, average asking rental rates will continue to increase 3% to 4% by year-end.