‘There isn’t some ugly trend going on Downtown,’ says Tim Cowden, senior vice president of Colliers International, reacting to double-digit office building vacancies. (photo/lambertphoto.com)

Vacancy rates at Class A office buildings Downtown are averaging 15.6 percent, says Craig Farrington, vice president of research at CoStar Group’s San Diego office. That’s an alarm bell to some real estate executives, a temporary spike to others.

At the start of 2005, vacancies were running at 8.5 percent and have been climbing steadily since then, says Farrington.

Several factors are behind the vacancy increases. New landlords are raising leasing rates to compensate for their investments, driving some rent-sensitive tenants out of their buildings. Thousands of square feet of new office space opened up with the completion last year of Broadway 655 (now called Advanced Equity Plaza) and this year’s debut of DiamondView Tower. Months passed before those buildings could start filling up.

“If those buildings hadn’t been built, we’d be in single digit vacancies,” says Tim Cowden, senior vice president of Colliers International. “But it’s temporary. It’s not catastrophic. These are normal market forces. There isn’t some ugly trend going on Downtown.”

No one knows what will happen when more than 1.5 million square feet of new office space comes online in the next few years with the future development of The Irvine Co.’s 34-story office tower and Manchester’s Pacific Gateway project.

Kraig Kristofferson, senior vice president of CB Richard Ellis, says the fact that DiamondView Tower and Broadway 655 have been well-received and well-leased is encouraging for those future office developments.

Kraig Kristofferson, senior vice president of CB Richard Ellis, and his associate, Stacy Meronoff, on the 15th floor of DiamondView Tower, which has a 16 percent vacancy.

Craig Irving, principal of Irving Hughes, a company that represents only tenants, says leasing rates in commercial offices Downtown are unprecedented and go as high as $4.10 per square foot. It does not bode well for some tenants. “When somebody pays a lot for a building, the only way to get a return on his investment is to charge higher rental rates,” says Irving.

Tenants in some quality Class A buildings are being hit with rent increases of between 40 percent and 100 percent when their leases roll, claims Irving. “Most are saying to themselves, ‘Do I need to be in this nice building with its nice views?’” he says.

Some tenants hit with higher rates are moving into Class B offices Downtown, where vacancy rates are 10.2 percent and average leasing rates are running at $2.40 per square foot compared to the average of $2.95 per square foot in Class A buildings (figures provided by CoStar Group Inc.).

Cowden says when one small law firm in Symphony Towers was facing a 20 percent increase in its lease at renewal, it moved into a Class B office at $1.90 per square foot per month. “It wasn’t Symphony Towers, but it was good enough,” says Cowden of the three-partner firm.

“With a 20 percent increase in rent, some firms, like a high-end law firm or real estate firm, will swallow that,” adds Cowden. “But if you’re a four-attorney law firm, for example, that increase comes out of your own pocket. It adds up. You can send a kid to Princeton or buy two fancy cars or put a down payment on a new home.”

Irving says the average office tenant Downtown occupies a 3,500-square-foot space. “It’s small businesses — almost mom and pop,” he says. “If a small law firm is paying $2.25 a square foot and the rent is going up to $3.25, that’s a significant increase. The firm is probably not making money as it is. That increase goes straight to their bottom line. They would have to work a lot more hours to pay for the increase, raise their billing rates for clients or figure out a way to take the hit in some other firm, like moving or downsizing.”

While some firms move, not many leave Downtown. “Rental rates in the suburbs are as high or higher than Downtown,” says Kristofferson. Adds Cowden: “There’s more square footage of tenants moving into Downtown than there are moving out of Downtown. There’s more absorption of office space. That’s a positive trend.”

Irving doesn’t agree. “In the last two years, there have been more tenants moving out of Downtown than the previous 10 years combined,” he says. “This will continue if rents continue to go up.” The high cost of parking and the lack of parking also are responsible for tenants leaving, he contends.

Brokers say the attractiveness of Downtown over suburban office markets can’t be underestimated. The amenities are many — fantastic views, short walking distances to stores, gyms and restaurants; access to public transportation and far fewer traffic hassles.

“Downtown doesn’t have any traffic jams,” says Cowden. “Compare that with trying to get into UTC, Sorrento Mesa, Del Mar Heights and Mission Valley. In Downtown, you never really sit for long periods of time because we have a spider web of transportation into and out of Downtown.”

Cowden believes there will be enough demand for high-end office space to fill “within a reasonable time” the towers that The Irvine Co. and Manchester Development are proposing. “Some of (the demand) will come from Downtown tenants and some of it will be from surburban areas,” he says. “It’s helpful to have new office buildings coming online every three or four years. Some Downtown firms will leave for that new space, opening up space for other firms wanting to expand.”