Insights into the activities of the San Diego County commercial real estate market, following the second quarter of 2017, are based on trends over the past four quarters since mid-year 2016.
San Diego's North County industrial market (2017), located along the Pacific coastline, about 35 miles north of downtown San Diego. It consists of a decentralized array of cities including Escondido, Vista, Carlsbad, Oceanside, and San Marcos. Corporate real estate investors and nearly 850,000 residents are drawn by the appeal of its coastal location.
Vacancy is predicted to remain below 5% on average across the region's industrial market throughout 2017. Record low vacancy is expected to continue, even though new construction is approaching the highest level in a decade. Industrial (including R&D) rental rates have stabilized at a record high of $1.03 SF per month and are projected to steadily increase, while low vacancy rates are maintained. This is predicted even while inventory increases as new projects with higher rental rates are completed.
San Diego county-wide vacancy dropped to 4.8% or below throughout the county's submarkets in second quarter 2017, a 29 basis point (bps) reduction from the first quarter. All of the submarkets remain below 9% vacancy in industrial (non-R&D) space. Total vacancy decreased negligibly (8 bps) in industrial inventories to 3.7% from the first quarter to the end of Q2 2017. R&D vacancy decreased across the county to 7.8% (an 84 bps reduction).
Currently, 598,583 SF are under construction of industrial facilities, 281,563 SF of which is to be completed later this year (2017). In the third quarter, the 55,573 SF Carlsbad Victory Industrial Park (Badiee Development) will be completed. The new 79,050 SF Siempre Viva Business Park Building 17 in Otay Mesa will be finished (Murphy Development). A 64,300 SF facility in Carlsbad Oaks East Business Park (Techbilt Companies) will wrap up construction. And, an 82,640 SF building will be finished in Poway Corporate Center this year as well.
Even supply and demand
Although San Diego County remained in a state of negative demand for office space throughout the first two quarters of 2017 (with negative absorption of 158,087 SF in total), this does not indicate a weakening of the vigorous regional office market. Large amounts of square area are scheduled to be absorbed during the second half of 2017, including city government office space downtown and Illumina in University Towne Centre.
These gains contribute to stabilization of demand in later 2017. Over the past six years, the area has enjoyed steady growth. And, construction is ongoing, with office real estate speculators scheduled to complete 512,133 SF of leasable space in late 2017 and an additional 247,766 SF or more in 2018. (Asking rates average $2.63 SF per month.)
Leasing declined 22% from the same period last year. In part, the reduction is due to increases in lease renewals, which are not reliably captured in reports of leasing activity. Though net positive absorption during 2017 is expected to be sustained, it is not predicted to be at rates as high as those from 2010 through 2016, during which average annual absorption was 1.1 million SF. 2017 absorption is more likely to be nearer 500,000 SF, reducing vacancy to about 11%. (Demand in Q2 throughout the county averaged –27,913 SF.
The largest decline in absorption over the past two quarters was at Rancho Bernardo (-51,024 SF), much accounted for by the new vacancy of the Sharp Rees-Stealy building (57,420 SF), and Mission Valley (-30,851 SF), largely due to several Valley Corporate Center and Centerside I tenants vacating a combined total of 39,969 SF in second quarter 2017.
High occupancy and low construction
Tech, military, medical, hospitality, and retail job gains are bolstering San Diego regional income growth and consumer spending. Numbers of new households in the area are steadily increasing, prompting completions of multi-family units to accommodate them. This dynamic yields numerous opportunities for area retailers reaping the rewards of meeting a growing population's needs for goods and services in convenient locations.
This developing trend has prompted consumer demand for urgent care outlets and professional medical offices to locate in retail spaces to provide convenient patient access. This increased demand is causing a shift to a more non-traditional tenant mix at regional retail shopping centers.
Additional retail space will become available later this year, in two projects at La Jolla's Westfield UTC providing a combined total of 400,000 SF. The remaining retail properties throughout the San Diego metro region consists of small spaces (under 10,000 SF).
Re-lease time is expected to be minimized by the absence of new retail inventories during 2017—a plus for San Diego retail property investors. Record low vacancy is predicted to motivate retail tenants to pay increased rates for premium space, which can be expected to offset the flattening of rates in some of the region's upscale submarkets.
Sustained growth projection
The San Diego local region has realized five consecutive years of job growth. Commensurately stable local economic conditions overall account for the apartment market's continued strength. Rent rates are predicted to maintain growth from 3-5% through the remainder of 2017.
The average multi-family sale price is at about $264 PSF, with the high end at $332 in the North Coastal region of the county, and the low end at $164 in the North Inland area east of the I15 corridor, and properties within the Central San Diego area selling at an average of $293 PSF.
Vacancy in San Diego proper is at around 3.4%, and county-wide vacancy is about 5%—which totals reflect the region's strong rental housing demand. This is although the SDCAA 2016 Fall Rental Survey revealed a spike in North County vacancy as a consequence of new apartment development in the Escondido and Vista satellite markets. And, the 2016 increase was from 2.6% in fourth quarter 2015.
There continues to be strong demand by investors seeking value-added and turnkey investment properties in the county. Further, a rather long-sustained stream of 1031 exchange capital fuels the San Diego real estate investment market. Interest rates have risen approximately 0.5% (50 bps) since mid-fourth quarter 2016. But, local lenders provide abundant access to financing for multi-family properties.
However, San Diego's most significant drop in construction during 2017 has been in multi-family development (50%). This has been largely attributed to the fact that so many multi-family building projects began in late 2016, causing a natural reduction in the number of permits issued in the first half of 2017.
Rental rates realized a higher rate of increase in San Diego County (11%) over the past year than any other Southern California county, out-performing Orange and Los Angeles counties (both at 7%), and Santa Barbara County (5%). This data is per the Real Estate Research Council Report, based on findings of Novato's Real Answers real estate research, as reported by the San Diego Union Tribune 6-5-17.
Managing supply surge
Positive momentum across a number of critical economic indicators are currently encouraging to California's tourism industry. Despite emergent uncertainties around the direction of federal tax, fiscal, and regulatory policies, the many indicators of continuing new job creation and steady consumption, consumer and business development confidence are both comparatively high. These factors appear very promising for San Diego travel through the remainder of 2017, contributing to a generally favorable forecast of conditions for hospitality investment.
Additionally, thousands of new upper mid-priced and high-end rooms have been added to the market, which could stimulate demand from prospective travelers previously priced out of the accommodations market in larger metro areas.
The 2017 increase in rooms is expected to flatten annual occupancy rates through the remainder of the year. Average daily room rates (ADR) and Revenue per available room (RevPAR) rates are also expected to level off in reaction to the increased supply . However, notwithstanding an unforeseen impacts on travel, California's long-range hospitality occupancy projections appear stable.
Record low industrial space vacancy (even with decade high new construction), a stable office real estate rental market, popular dynamics yielding multitudinous retail space investment opportunities, multi-family unit rental rates sustaining 3-5% growth throughout the year, and a stable hospitality market are all very promising signals of a healthy San Diego commercial market.
Potential impacts to the region that may yet stem from regulatory and fiscal volatility at the federal level in 2017 are acknowledged. However, ongoing job creation, stable rates of consumption, and strong confidence among business developers in the region, all together appear to amount to a year promising moderate but relatively reliable growth across the San Diego commercial market segments.