Mark Read, senior managing director with CB Richard Ellis, says San Diego County's strong commercial real estate market has become the darling of institutional investors. (photo/lambertphoto.com)

When it comes to the success of commercial real estate in San Diego County, experts break it down to these variables — quality and quantity. Local industry leaders say they see an overall good outlook for commercial real estate in the county this year, from office and industrial to retail. The main reason for that is the continued strength of the region’s economy.

“The San Diego economy is healthy, very healthy, compared with most of the country,” says Mark Read, senior managing director with CB Richard Ellis. “San Diego County has emerged as a real darling, if you will, of the institutional investors.”

That status is due in large part to continued positive, albeit slow job creation, and a diverse and growing economy. Low interest rates are another factor.

“All combined to make 2003 an exceptional year for sales,” Read says. “Almost across the board, sales of buildings to users (companies that occupy the space), sales to local private investors, and sales to institutional investors were all at really record levels.”

CB Richard Ellis saw 55 percent of revenue from sales last year. Historically, leasing holds that percentage. The company’s mortgage business was up 40 percent compared with 2002 — and ’02 was a good year. “We see that continuing in ’04, thanks to expected low interest rates through election season,” Read says. “We expect another bang-up year in mortgage banking.”

Demand continues to outpace supply, however — a theme resonating through all sectors of the real estate business.

“Part of the reason that San Diego has such appeal to institutional investors is there’s a constraint on supply of land,” from residential to shopping center, office and industrial sites, Read says. “There just is a scarcity … on supply, particularly in the central part of the county.”

That trend is seen in La Jolla, for example.

“There isn’t a tremendous amount of vacancies, either retail or office,” says Phil Wise, senior vice president at Colliers International, who deals specifically with La Jolla. “And what good property becomes available moves fairly quickly if it’s good, quality product.”

The same goes for Downtown.

“We have had 14 years of no new office buildings Downtown, and what that has done is create a market where you have very limited good options as a tenant,” says Jason Hughes, co-founder and principal of broker Irving Hughes.

San Diego County’s commercial markets are divided into submarkets. La Jolla, for example, is a submarket of the North Cities market in CoStar Group’s 2003 analysis of San Diego office space. CoStar Group Inc. is a national real estate tracking firm.

Vacancy rates for San Diego’s office markets in 2003 were as follows, CoStar’s numbers report:

• North Cities: 15.8 percent.
  
  
• Central Suburban: 9 percent.
  
  
• Downtown: 11.8 percent.
  
  
• South/Southeast Corridor: 5.6 percent.
  
  
• Interstate 15 Corridor: 13.9 percent.
  
  
• North County West: 11.4 percent.
  
  
• Highway 78 Corridor: 6.1 percent.

San Diego’s overall office vacancy rate decreased to 11.7 percent as of the fourth quarter of 2003, CoStar reports. That’s down from 12.5 percent at the end of 2002.

“We see in ’04 continued strong growth in North County, particularly Carlsbad, and in South County, particularly EastLake and to a certain extent Otay,” Read says, noting the attractiveness of planned communities to commercial developers.

Read also predicts higher densities and migration by residents and companies to the north and south ends of the county, and Southwest Riverside County.

Snapshot: La Jolla

“In every market you have high-quality space and high-quality tenants,” Wise says. “That (space) moves quickly.”

In La Jolla, the most desirable office and retail buildings run along Prospect, Girard, Fay and Silverado, all close to the ocean. “The nice component is that they have whitewater views,” Wise notes. “The view is unbelievable.”

Those high-end locations are in contrast to locations along streets such as Pearl, where there is more traffic and less view, Wise explains. “It’s a C building versus a B-plus or A building.”

Commercial space is classified using a grading scale, primarily A, B or C. Class A buildings are considered the most desirable from an investment standpoint. They feature more recent, high-quality construction, better design, security and various “bells and whistles,” Hughes explains. The scale goes down from there.

Premier space in La Jolla will lease for $3 per square foot and up — if the building is in tip-top shape, with upgrades, or if it’s new — says Wise, who made his first deal in La Jolla in 1981.

Monthly leases along Pearl Street cost about $1.75 per square foot while a space on Prospect with an ocean view may fetch $3.65.

Despite its views and tony addresses, La Jolla has ridden a changing wave of desirability. Before the University Towne Centre area developed in the mid 1980s, the village was golden for financial firms. “La Jolla was its own entity,” Wise says. “There was no University Towne Centre. And it was a very desirable place. People lived there. They wanted to work where they lived.”

The major stock brokerage firms came to La Jolla because there was so much money in the area. Once UTC came on the scene, however, “La Jolla just dried up,” Wise recalls.

The market swung in La Jolla’s favor again as UTC office space neared full. “La Jolla again became its own entity, and it filled up,” Wise says. Today, the major brokerage firms are back, along with a plethora of banking institutions, “again because there’s so much money in the village.”

Wise also notes a surprising number of national retail tenants have taken an interest in La Jolla. Beverages & More has leased 7,000 square feet on Pearl Street, he says. High-end furniture retailer Ligne Roset leased 5,600 square feet in the former Cove Theater.

Lifestyle Centers

The arrival of more national retailers in La Jolla underscores a trend in lifestyle centers elsewhere, says Read. The Forum shopping center in Carlsbad is an example.

“That’s newsworthy. I mean, that’s a different center,” says Read, whose company handled the property. “That’s the first true lifestyle center with mall-type, high-end retail tenants that’s not in a mall.” Designed to resemble a village more than a traditional shopping center, The Forum is home to such retailers as Z Gallerie, Victoria’s Secret, Bombay, Sushi on the Rock, Tilly’s and Borders Books and Music.

The development of lifestyle centers has come about partly because of the lack of traditional mall-type centers, Read explains. “There’s just a lack of available sites.” Demographics are another reason. The tight market has led to an extremely low retail vacancy rate of 2.7 percent countywide, he says.

Tale Of Two Submarkets

Del Mar Heights and Sorrento Mesa lie inside CoStar’s North Cities market, but their profiles couldn’t be more different, say local experts.

“The fourth quarter of ’03 marked the fifth straight quarter of positive absorption,” says Read. Absorption is the change in occupied space from one period to the next. “The most productive market was Del Mar Heights.” Rents stabilized and went back up a bit, particularly the Peregrine campus, now virtually fully leased.” All in all, Del Mar Heights was the most active, with the highest rents and the most absorption.

Sorrento Mesa is considerably weaker. “It’s interesting that they’re pretty close to each other,” Read notes. “Sorrento Mesa struggles.”

CoStar’s numbers underscore the disparity. With 35 buildings, Del Mar Heights’ vacancy rate was 16.7 percent, says CoStar’s year-end 2003 report. Sorrento Mesa, with 21 buildings, had a vacancy rate of 23.4 percent. “Sorrento is a bloodbath right now,” Hughes says. “There are a tremendous amount of options if you’re a tenant.”

Landlords are getting aggressive, offering free rent and tenant upgrades as incentives, Hughes adds.

Why The Empty Space?

“The reason is they were pretty hard hit by the downturn in the wireless, telecom and some of the high-tech industries,” Read explains. More space was taken than was really needed in 2000 and 2001, and tenants had to sublease what was open. In some cases, the space was never occupied, he says.

Read expects the numbers to improve this year.

Looking Ahead

The tight market and high demand put Carlsbad’s Bressi Ranch development in a strong position, says Read, who sees signs of improvement in the office and industrial leasing market. He predicts the start of another development cycle for suburban office and industrial space by the end of this year, citing Bressi Ranch as part of that cycle. A 126-acre business park site will front the 600-acre residential planned community, located along Palomar Airport Road and El Camino Real.

“We’ve just had phenomenal demand from developers and users for those sites,” he says.

In South County, Read expects to see continued strong growth in demand in the EastLake area of South County and the Highway 125 corridor.

“I see the market Downtown firming up more,” Hughes predicts. “There’s going to be more space leased, more net absorption, meaning more space leased than vacated. So it’ll be a positive year for landlords.”

Just as Read sees another development cycle looming, Hughes predicts a high lease turnover Downtown, which isn’t unexpected. Leases run out in cycles, and that cycle is coming around starting the second half of this year, through all of 2005 and 2006, reports Hughes. “More of our tenants right now are expanding than contracting,” he notes.

CoStar’s office market analysis foresees a 16.8 percent lease expiration rate this year, followed by 15.1 percent in 2005 and 12.1 percent in 2006.

One key high-rise that’s being watched with great interest Downtown is Broadway 655, set for completion in summer 2005. “There’s a tremendous amount of interest by tenants looking at that building,” Hughes says, adding that tenants will most likely accept paying more for a new space in a high-quality building.

The 23-story Broadway 655 will help fill the 14-year gap in fresh office space Downtown at a time when the area is maturing, says Hughes. “You can’t come down here without seeing building cranes everywhere,” he says. Maturation in residential, retail and hospitality “will ultimately have a huge influence on employers relocating into Downtown.”