Emerald Plaza was one of three buildings that made up one sale in Downtown’s biggest transaction. (photo/Maya Ellman)

Last year San Diego’s commercial market was the darling of institutional investors groping for asset purchase opportunities in a deal-starved America. The numbers over the past year now demonstrate that a lot of deals were made in record volume and all over the region. The institutions have completed most of their bargain shopping in San Diego and are moving to other regions.

But the owners of commercial properties, identifiable commercial land and their brokers are now in the catbird seat. The tenant market is over. There are few remaining bargains.

The current commercial market is a resultant blend of low inventory, little new construction, buildable land scarcity and high absorption. In its latest report covering the second quarter of 2004, CB Richard Ellis reports the following:

• Current vacancy rate: 10.7 percent (5.2 million square feet).
  
  
• Total inventory: 49.2 million square feet.
  
  
• Net absorption: 405,000 square feet.
  
  
• New construction: 1.2 million square feet.

Driving this landlord’s market is a diversified workforce, low unemployment, growing regional production and a strong housing market. It is a veritable wonderland of high-end, stabilized well-performing assets in a market that could and should get tighter and more constrained. Even those markets with double-digit vacancies, notably Sorrento Mesa and Miramar, should see a tightening as the year progresses and the economy grows.

We continue to monitor Kearny Mesa, the best example of an evolving office market. Still dominated by industrial inventory, with a standing inventory of 18.3 million square feet, the commercial market now is 4.7 million square feet and growing. About 16 percent of properties classified as industrial were built prior to 1990, suggesting that over the foreseeable future this inventory will be transformed and upgraded to commercial office as companies recognize the excellent location of this central San Diego market as an ideal place to locate. Today barely 40 acres of land are available for purchase out of a total 2,300 acres in the market, so there will not be an immediate surge of inventory, but opportunities will emerge.

Major Office Building Sales

Looking at the past fiscal year (July 2003 through June 2004) the number of major office building sales (property that sold for more than $10 million) has significantly diminished, recording a total of 27 deals compared to 35 deals from the prior year. However, the total value of those transactions exceeded the prior year, $1.33 billion vs. $1.06 billion. This came about as the average transaction value rose from $189 per square foot the previous year, to $225 per square foot this year.

The most significant sales took place Downtown, with seven transactions, followed by Mission Valley, Rancho Bernardo and Kearny Mesa. Contributing to the big Downtown count was what is believed to be the largest ever Downtown transaction, when three buildings — Emerald Plaza, CoAmerica and Golden Eagle Plaza — were sold by Southwest Value Partners to Triple Net Properties LLC. (Southwest continues to manage the properties.) These were the latest of 14 transactions in total that have taken place Downtown in the past 18 months, a phenomenon which this column first observed a year ago.

This spectacular sales run is likely over as much of the institutional money responsible for these buys has now shifted to less stabilized but emerging commercial markets in the Midwest and Eastern parts of the United States.

Suburban Markets Are Dominant

The May sale of the NBC building for $95.5 million was one of the standout sales Downtown. (photo/Maya Ellman)

Little significant new construction in the region has taken place in the past year. Most of the new development is of decent quality scattered throughout various markets. Interestingly, the southern Riverside County community of Temecula has 374,000 square feet under construction (on top of an inventory of 1.5 million square feet), making it the most robust market in the region. It now counts as part of our local story because it is a provocative demonstration of how our communities are growing: the office space and jobs are evolving toward those communities able to accommodate their residents. Del Mar Heights is another continuing example of the suburban commercial phenomenon, about to add another 194,000 square feet to its formidable inventory of 3.3 million square feet.

Downtown is coming out of its construction hibernation with the development of the 373,000-square-foot 655 Broadway by Lankford, the first such development since the opening of One America Plaza in 1991. Interestingly, this is not a pure office building. The project includes 10 residential units, a mix of uses in the previously all-commercial corridor of west Broadway.

Mixed use seems to be capturing the imagination of developers in many disparate ways. With more than 10 million square feet of commercial office space, relatively few Downtown jobs are being held by Downtown residents. Yet the majority of Downtown residents work Downtown.

Centerside I in Mission Valley sold this summer for $65 million - a hefty $320 per square foot.

Another trend in office construction also is emerging Downtown: the office condominium. At least three projects are in the planning stages to accommodate those businesses, mostly small space users who desire to own their space rather than lease. This is a concept I have long discouraged, principally because the asset is not easily fungible on the resale market. But more supply may make this issue moot.

New commercial development will continue to emerge Downtown, although the redevelopment pundits have virtually ignored the opportunity of Downtown as a potential technology center and have yet to effectively market the central and eastern Broadway and C Street corridors as targets for commercial growth.

Land is not in short supply. The shortage is in creative leadership to help the Downtown market diversify beyond its strong residential base.

Day Of The Landlord

Look for a tightening of all commercial inventory throughout this year and into next as the economy grows, employment increases, new companies emerge and optimism prevails. Average lease rates in the county, now hovering just below $2 per square foot per month, will negotiate above that marker, and in some markets such as UTC, Torrey Pines, Del Mar Heights and Downtown, closer to the $3 level.

For tenants, the relatively soft market of the past couple of years was fun while it lasted. Now they will just have to make more money to pay their rent, a goal that shouldn’t be all that hard to achieve for most in this most active and prosperous region in the United States.

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@sandiego metro.com.