San Diego revs up

For a long time Californians looked on San Diego as little more than a Navy town, and the towns north of it as a series of beach retreats and retirement villages. No longer. The city, now the second-largest in the state and sixth-largest in the nation, has turned itself into a major economic engine, while the northern and eastern suburbs have become hubs of research and entrepreneurial activities.

Over the past five years, the San Diego Metropolitan Statistical Area, which includes much of the western half of the county (where 80% of the population lives), has added 153,000 new jobs, increasing employment 16%. Five years ago, unemployment stood at 7.7%. Today the rate is 3.5%. In 1998 alone, the MSA added some 46,000 new jobs, bringing total employment to 1.1 million jobs

According to the California Department of Finance, San Diego County had a population of about 2.8 million at the end of 1998. It projects population will grow by 58,000 this year, with in-migration accounting for 55% of that. The San Diego MSA had a population of approximately 2 million last year.

The San Diego County Chamber of Commerce estimates the county's gross regional product hit $87.9 billion in 1998. The 1999 forecast calls for it to reach almost $93.0 billion, for an inflation-adjusted annual change of 3.2% - compared to 2.5% for the state overall and 2.1% for the nation.

Despite the positive projections, the Chamber points out the rate of growth is slowing. The University of San Diego Index of Leading Economic Indicators shows the economy growing only 1.8% this year, compared to 2.7% in 1998 and a record-setting 4.5% in 1997.

The Chamber calls foreign trade the region's most vibrant industry. It reports San Diego's international trade totaled a record $22.1 billion in 1997, the most recent year for which it had statistics. From 1990 to 1997 international trade in San Diego more than doubled, including a 19.6% increase in 1997 alone.

Predictably, Mexico accounts for the majority of foreign exports through San Diego and 99% of imports, according to the Chamber, which also says the county's two border crossings with Mexico are the busiest in the world, with more than 50 million (legal) crossings annually.

The Chamber says the area also benefits from new industries like biotechnology, software, environmental technology and telecommunications, whose companies it characterizes as "gazelles" that quickly evolve in reaction to market trends. Most importantly, the organization adds, these firms drive wealth creation by offering wages between 30% and 120% above the regional average.

San Diego has nearly 250 bio-tech companies (only Boston and San Francisco have more) with the majority located from La Jolla north, drawn by the presence of the University of California at San Diego and the Scripps and Salk institutes. Multimedia, software, Internet and other high-tech firms also gravitate to the area.

Downtown San Diego continues the renaissance that began in the 1980s with construction of Horton Plaza. Today more than 50 major commercial and residential projects valued at $3.5 billion are in the downtown pipeline, according to the local office of Grubb & Ellis.

The most significant is a new ballpark for the San Diego Padres. The companion Ballpark District plan calls for 150,000 sq. ft. of retail space, 850 hotel rooms and 600,000 sq. ft. of office space, but developers are also building retail, hotel and multifamily space along the district borders.

Brokers rate Mission Valley the most active area of the city for hospitality, retail and apartment growth and the northern part of the city, including the adjoining suburbs, as the most active office and R&D growth area. Historically the north area has been the most active industrial market, and retains that status today, but rising land prices and rents are forcing traditional industrial uses to move to Poway and other areas to the south, giving way to R&D and mixed-use developments.

As an example of this, Miami-based Lennar Corp. is turning the 232-acre General Dynamics property in Kearny Mesa into a 4.5 million sq. ft. project called San Diego Spectrum. The development will include retail, housing, office and hotel uses.

In general, master-planned, mixed-use projects such as the Spectrum and the ballpark district are becoming a common characteristic of the local landscape. In another example, the San Diego State University Foundation started construction on a 131-acre, $500 million redevelopment project that ultimately will have 300,000 sq. ft. of retail space, 3,100 multifamily units, 710,000 sq. ft. of office/R&D space and a 300-room hotel with conference center.

Additionally, several companies are working on the 215-acre Mission City development in Mission Valley, which will have office, retail and residential space. On a smaller scale, in Mid-city San Diego, a 51-acre area is being redeveloped as The Grove, with retail, housing and a small amount of office space.

The prime mover is growing community pressure to create an attractive environment, preserve open space and reduce congestion by putting housing, work, shopping and leisure options in one place.

Investment sales in most categories for first-half 1999 were down from the same period last year. Brokers attribute the decline to lack of product, not lack of interest. Also, markets are performing so well that many investors are sitting back and enjoying the returns rather than looking for new capital.

According to Chris Loughridge, senior vice president in the San Diego office of Voit Commercial Brokerage, good properties in most categories are trading at cap rates around 9%. "Obviously, particularly low- or high-quality properties are above or below this mark, but I would call this a good benchmark," he says.

According to Loughridge, investors who bought into the market two to three years ago are in position to make hefty profits. But he says it is increasingly difficult for new investors to buy in. "You need a lot of capital to get in here," he underscores. Nonetheless, he calls San Diego an excellent long-term investment prospect for those who can afford it.

"People like San Diego because most of our economy is based on growth industries," he comments. "There is some level of concern about relying on new industries, but most people seem to agree we're going through a technological revolution that guarantees these industries a strong future. Consequently, there's not the market risk that there was in 1989 when people were making decisions based on what turned out to be an outmoded view."

Office The San Diego office market has been slow to recover from the recession. Overall vacancies still hover around 10%, although that figure is trending downward.

The overall office vacancy rate in central San Diego at midyear was 9.6%, the lowest level in 20 years. CBRE shows Mission Valley, Kearny Mesa and the La Jolla-University area with vacancies in the 6% to 7% range, the lowest among the major markets. Some smaller markets such as Del Mar and Governor Park have vacancy levels under 5%. Grubb says leasing is especially strong downtown, with more than 200,000 sq. ft. of absorption projected for the second half of 1999.

In July, the county recorded its largest office lease transaction ever, when Peregrine Systems leased 420,000 sq. ft. in Del Mar Heights. The $175 million transaction with El Segundo, Calif.-based Kilroy Realty Corp. includes delivery of four buildings over the next three years, as well as an option on a fifth.

According to Grubb & Ellis, monthly Class-A rents range from $1.95 a sq. ft. in Mission Valley mid-rises to $2.50 a sq. ft. for top floors of prestigious downtown high-rises. As a result, some companies are looking for lower cost alternatives including conversion of basic R&D buildings into offices. CB Richard Ellis pegs the overall average rent at $1.59 per sq. ft., up 4.4% from a year ago.

Grubb reports 41 central county office properties valued at $158 million sold in the first half of this year, the lowest sales volume there since the recession. The median price per square foot, however, was $97.26, which is just under the median price paid during the past 24 months.

According to Jon Cavan, president of Cavan Co., Class-B and -C buildings trade for a minimum of $60 to $90 per sq. ft., with Bs maxing at $115 to $120 per sq. ft. Class-A properties sell for $160 per sq. ft. However, he says relatively few sales are occurring.

Industrial The North American Free Trade Agreement spurred vast industrial investment in Mexico because of the low-wage environment. This in turn created manufacturing jobs in San Diego because many local companies are suppliers to factories on the Baja Peninsula, and vice-versa.

According to John Walz, a senior vice president in the San Diego headquarters of Burnham Real Estate Services, investment in Baja California reached $1.6 billion last year, a 7.1% increase. He says more than 1,000 "maquiladora" factories operate on the Baja peninsula.

As evidence of the growing strength of foreign trade, San Diego was one of 10 U.S. metropolitan areas to expand exports more than $1 billion in 1997, according to the U.S. Department of Commerce. The Chamber lists electric and electronic equipment as San Diego's top manufacturing export, followed by industrial machinery and computer-related products.

According to Mike Philbin, a senior vice president with Burnham's Carlsbad office, the county's industrial market reported record construction levels the past two years, with an anticipated total of 7.7 million sq. ft. of industrial and 2.7 million sq. ft. of R&D space for 1999 set to break the record again.

Though the Construction Industry Research Board reports a 22% decline in industrial construction dollar volume for the first half of 1999 compared to the first half of 1998 ($94.13 million vs. $120.95 million), much of last year's total involved projects coming on line this year. The market will see the results of declining numbers for '99 next year.

Philbin considers a decline appropriate, since industrial and R&D vacancies climbed from 7.8% to 12% and 7.7% to 14.7%, respectively, from January through June of this year. He predicts vacancies will be down by December and return to equilibrium in 2000.

Activity has been high. Landlords leased 2.9 million sq. ft. of industrial space last year, according to David O'Rell, research director for the San Diego office of Grubb & Ellis. He says the market is on target to top that figure this year.

He singles out Poway as particularly healthy, having leased twice as much space as any other submarket. Poway logged net absorption of 669,208 sq.ft. in the first half of 1999 and 1.5 million sq.ft. from January 1998 through June 1999. He attributes the submarket's success to the opening of Scripps-Poway Parkway.

The brokerage picks Otay Mesa as the next industrial powerhouse. With nearly 300,000 sq.ft. of net absorption through June, it was second to Poway. It boasts comparatively low lease rates of $0.42 per sq. ft. and land prices of $2 to $6 per sq. ft., depending on infrastructure improvements, entitlements and freeway proximity.

Grubb & Ellis pegs asking rents in central county at an average of $0.64 per sq. ft. for standard industrial and $0.90 triple net for R&D/flex space.

On the investment side, Grubb reports 38 industrial facilities in central San Diego County sold through June for a total of $155 million. The median price was $79.09 per sq. ft. - the highest since the late-1980s.

Retail Mike Moser, a broker in the San Diego office of CB Richard Ellis Retail Services, reports the county's retail vacancy rate decreased marginally in the past year, dropping to 6.25% in second-quarter 1999 from 6.77% in second-quarter 1998. However, the market experienced not quite 200,000 sq. ft. of positive net absorption for second-quarter 1999 compared to nearly 475,000 sq. ft. for the period last year.

Moser says average asking monthly rents rose to $1.52 per sq. ft. triple net, with the lowest submarket average $1.16 per sq. ft. in Escondido and the highest $2.50 in the Del Mar/Solana Beach/Rancho Santa Fe area.

CBRE says 2.4 million sq. ft. of retail space was under construction at the end of the second quarter. The largest retail project is locally based H.G. Fenton Co.'s 535,000 sq. ft. Fenton Marketplace in Mission Valley, where the tenant roster is strictly big-box users, including IKEA, Lowe's, Home Depot and Costco.

Downtown San Diego has multiple projects in development. In addition to the projects connected with the ballpark, San Diego-based DDR OliverMcMillan is set to begin building Gaslamp Entertainment Complex Phase II, with plans to start phase III next year. New tenants will include Borders, Sega GameWorks and a 15-screen Pacific Theatres cinema.

Also in 2000, Los Angeles-based Champion Development Group will begin the $100 million Gaslamp Square, the Gaslamp District's largest single project. A partnership led by San Diego-based Malkin Properties plans 540,000 sq. ft. of retail and office space nearby.

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