San Diego

An optimistic stirring snakes through the commercial real estate market here with industrial/R&D and retail segment showing the most gusto and the road of opportunity ever widening for the apartment, hotel and suburban office sectors. While the downtown office market remains dreary, the commercial market as a whole continues to attract attention from foreign investors (principally Germans and Japanese) shopping for bargains.

The good news, says Dr. Mark J. Riedy, professor of real estate finance at the University of San Diego, is that "the bad news is behind us" and the region is geared for growth in what Mayor Susan Golding has identified as the "four Ts: technology, trade, telecommunications and tourism," supplanting defense and aerospace which once dominated the local economy.

Catching up and pushing ahead at the same time, the public sector - local, state and federal entities - have embarked on a five-year, $14 billion infrastructure repair, improvement and expansion campaign which ranges from street and highway improvements to a new airport terminal, new central library and major expansion at the convention center (where Republicans will nominate a presidential slate this August) and San Diego Stadium (site of the 1998 Super Bowl).

San Diego County opened its $56.7 million Hall of Justice downtown last month, consolidating 16 Superior Court civil courtrooms and district attorney, marshal and probation offices. Completion of the project marked a successful public/private-sector collaboration in which the 13-story county-owned building was finished ahead of schedule and under budget by the San Diego-based development team of Lankford and Associates, Hensel Phelps Construction Co. and architects Carrier Johnson Wu, which utilized a modified design-build approach to pull off the fete.

While getting the government services into 397,000 sq. ft. under one roof will save county taxpayers money, it empties previously leased office space in an already soft downtown market running at 20% vacancy. The courts vacated 29,718 sq. ft. for which the county was paying $47,425 a month on a lease scheduled to expire May 1997 in Home Savings Tower, and the district attorney moved out of 64,000 sq. ft. in the Wells Fargo Bank Building.

Suburban office tightening

Net absorption of Class-A space throughout the county last year was around 540,000 sq. ft., with brokers reporting a tightening in the suburban markets. Outside of downtown, finding blocks of space totaling 30,000 sq. ft. or more is difficult, says Pat Rohan, senior vice president at Grubb & Ellis. Occupancy is improving dramatically in Del Mar Heights, University Town Center (UTC) and Kearny Mesa, Rohan says, with monthly lease rates ranging from $1.15 a sq. ft. in Kearny Mesa to $1.60 a sq. ft. at Del Mar Heights and UTC. Office building sales to institutional investors and others reached an all-time high in 1995 prompting analysts to surmise the "bargain basement" days may be history.

The California Public Employees Retirement System (CalPERS) jumped into the market in a big way, purchasing the 265,500 sq. ft. Wateridge Plaza on seven acres in suburban Sorrento Mesa for $16.9 million, and, in Mission Valley, the 191,373 sq. ft. Mission City office for $18.5 million, and the 199,000 sq. ft. Centerside II office building for $16.2 million. In UTC, Equitable Life purchased the mixed-use Aventine (Hyatt Hotel, office, restaurants, health club) for $75 million. "I think we'll see some spec office development of high-tech flex space in places like Sorrento Mesa this year or next, and that will be the first in four or five years," Rohan says. "There's a lot more confidence in the suburban market as occupancy and rents rise."

Industrial absorption generates activity

R&D and industrial absorption last year totaled 2 million sq. ft., according to John Burnham & Co., dropping vacancies to the 8% to 10% range in 1996 and generating construction activity which produced more than 500,000 sq. ft. in build-to-suit properties. With only a handful of properties with more than 50,000 sq. ft. available early in 1996, it also sparked interest in new spec projects, including Security Capital's 200,000 sq. ft. building in Miramar and 350,000 sq. ft. project at Carmel Mountain Ranch on the 1-15 corridor.

About a quarter of last year's industrial/R&D absorption was in North County in the Highway 78 corridor, which includes Oceanside, San Marcos and Vista, and another quarter was absorbed in South Bay, which includes property along the U.S.-Mexico border at Otay Mesa.

A strong need is seen for multitenant industrial properties in central San Diego County (Kearny Mesa, Mission Gorge, Mission Valley) and along the border, where vacancy is expected to dip to 6% this year, according to Burnham, which also predicts increased land sale activity as users vie with developers for control of land and construction of needed properties. Land prices are ranging from $3.50 to $6 a sq. ft. and Burnham predicts they will rise 10% by 1997.

Retail centers remodeling

Remodeling and expansion of long-established regional centers like Fashion Valley, Mission Valley and Grossmont Center and the relentless march of the big-box retailers marked the retail scene last year and is expected to continue throughout 1996. Fashion Valley is spending $100 million on a 450,000 sq. ft. expansion and Mission Valley recently added a $10 million, 20-screen AMC cinema complex, which is expected to draw an additional 2 million to the center annually. By the end of next year, all three will be served by the San Diego Trolley, a light-rail transit system which will soon be capable of moving commuters from the Mexican border to San Diego Stadium in the heart of Mission Valley.

Trolley Lines already serve the border area and East San Diego County, including El Cajon and Santee.

More than 2 million sq. ft. of retail space was absorbed in 1995, and the same amount is expected to be absorbed this year, according to Grubb & Ellis. Last year's absorption was negatively impacted by the closing of 11 Silo locations. TJ Maxx's acquisition of Marshalls and the departure of Smith's Food from three of its four San Diego locations may have the same impact this year.

Much of the new space is expected to be occupied by discount-anchored tenants, mainly in North County. Federated's acquisition of both Broadway and Bullock's department stores and their consolidation under the Macy's banner will increase vacancy in regional malls.

"The good news," according to Jim Flocke of Flocke & Avoyer Commercial Real Estate, San Diego, "is that San Diego County is now viewed as a primary market by nearly all anchor retail chains and so far, as anchor space has vacated, there has generally not been a shortage of replacement candidates."

Average effective rent is running from $1.03 a sq. ft. per month, triple net in south central San Diego to $1.48 a sq. ft. along the north coast. The average central San Diego rate was $1.37 per sq. ft. per month. According to Bryan Holker, president of BH Holdings Inc., retail investment transactions totaled $94 million with 25 transactions last year, compared to 24 transactions totaling $193 million in 1994.

Hotels making strongest comeback

Of all the commercial sectors, hotels may be making the strongest comeback in San Diego and elsewhere in Southern California, according to William Hoffman, president of Trigild Corp. "You can't find the steep discounts of a year ago," Hoffman said. "Last year properties were being acquired for 30% to 40% of replacement cost and this year it's between 70% and 80%. Occupancy and earnings have improved, for sure, but property values have improved even more dramatically."

Hoffman predicts the improved showing bodes well for the prospect of new construction. He said the REO feeding frenzy seems to be over and Wall Street lenders like Lehman Brothers and Nomura appear willing to get back into the hotel business and banks and S&Ls are renewing loans on good existing performing properties.

"In a couple years, I think you'll see some substantial hotel construction," Hoffman says. "Demand for rooms never has decreased here, but occupancy percentages went down as supply increased. I think Califonia's new approach of having private industry promote tourism will boost demand throughout the state, and the GOP convention will draw a lot of attention to what tremendous value can be found in San Diego."

Strong apartment demand

With sales and construction permits on the rise, the apartment sector is looking at strong demand, according to Burnham & Co. vice president George Carlson. The 638 sales last year represented a 6% increase over 1994.

Carlson says there are plenty of buyers, but a limited supply of product. "The REO lender-owned sales have basically run their course, dragging down apartment values in the process," Carlson says. And, even though the sales increased, the number of units sold fell, from 13,950 in 1994 to 13,162 last year. "This decline can be attributed to the drop-off in REO sales in 1995, when there were only six REO sales of projects with 100 units or more, compared to 19 such sales the previous year," Carlson says. Unit prices in REO properties have remained fairly constant at $30,900 the past two years, while the average unit price for non-REO properties fell 8% to $44,900.

Countywide vacancy dropped from 8% to 6% last year, with some areas reporting only 2% to 3% vacancies.

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