Glut of office vacancies persists along I-15 corridor; lease rate per square foot lags behind county average.

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The San Diego County office market is shifting in reaction to the housing and mortgage industry crisis, economic strife and plentiful supply, local commercial brokers say. The Interstate- 15 corridor market is a prime example of growing inventory versus slowing interest.

Newport Beach-based Voit Commercial Brokerage, which has offices in San Diego and Chula Vista, reported that vacancy rates increased significantly due to the completion of 1.1 million square feet of new office construction in the first half of 2008.

Office vacancy rates ended at 13.4 percent in the second quarter, according to Voit's research, a 15.4 percent increase over second quarter 2007 of 11.6 percent.

The 1-15 corridor through Scripps Ranch, Rancho Bernardo, Poway and Escondido is one market seeing a significant slowdown. Vacancy rates for the market surpass the county average. In the second quarter, vacancy rates topped 14 percent, according to Jerry Holdner, vice president of market research at Voit. Vacancy rates were up to 8 percent at the start of 2005.

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"Construction is outpacing the growth at the moment," Holdner said. "So the vacancy rate is going to continue to rise."

In 2006, negative 140,000 square feet of office space was absorbed and only 489,500 square feet in 2007, Holdner said.

Rent-Free Promotions

David Marino, principal with Irving Hughes, said concessions have increased, including free-rent promotions and tenant improvement packages. He said rent increases are down. The average rental lease rate per month per square foot is $2.43 in the 1-15 corridor compared to a county average of $2.76 per foot per month. Meanwhile, the average time on the market is up. Still, developers continue to build.

"The office market on the I- 15 corridor probably hasn't been in a worse condition in 15 years," said Marino. "And there are a lot of reasons why it's a train wreck."

Marino said the average office space in the 1-15 corridors sits for almost two years before being leased.

"Three quarters ago it was 13 months and it is now up to 22 months, which shows the softness of the market. Space is just sitting, sitting and sitting."

In comparison, the average time on the market in Kearny Mesa is 20 months and in Carlsbad is 18 months, he said.

Cushman & Wakefield broker Marc Posthumus agreed concessions in this market increased in the past two years but does see improvement in the overall health of the market.

"We do have positive news. We have positive absorption," said Posthumus.

The local broker noted that the 1-15 corridor had 188,000 square feet of absorption in the second quarter and lead all other office submarkets countywide. Carlsbad was second with 119,000 square feet of absorption. Absorption had been negative or flat for the past two years in this mid-county market, according to Posthumus, with most of the absorption this quarter in Rancho Bernardo, Scripps Ranch and Sabre Springs.

Posthumus said notable new tenants in this submarket recently include national defense contractor Lockheed Martin with 157,000 square feet of space in Horizon Tech Center in Scripps Ranch, Sunnyvale-based Marvell Semiconductor Inc. signed for 9,030 square feet in Scripps Ranch, San Diego-based law office Morris & Sullivan LLP, National Pen Co. of San Diego and San Diego-based SmartDraw.com.

One Example

One example of how a single tenant can significantly affect the market is the recent leased signed by Bridgepoint Education. The local private education provider accounted for the most of the 156,000-square-foot absorption of Sabre Springs, according to Cushman & Wakefield. The brokerage reported that this lease tightened the vacancy rate from 18.9 percent in the first quarter 2008 to 10 percent second quarter.

Posthumus said only one office project will be completed by year end. Phase one of Bernardo Terraces by Los Gatos-based Granum Partners will be completed in the third quarter.

"There was a panic in the market that the 1-15 corridor might be overbuilt, but I don't think that is happening. I think the pace of absorption is keeping up with the new product," said Posthumus.

There is currently 10.9 million square feet of office space in this submarket with 1.1 million square feet under construction, 1.9 million square feet planned and 1.5 million square feet just sitting with no tenants and no lease, according to Voit.

There is 2.6 million square feet of office construction under way in the county.

A year ago, 4.1 million square feet was under construction in the second quarter. Planned construction is also down compared to last year.

In the second quarter there was 10.4 million square feet of office space on the books compared to 10.8 million square feet of office space for the same quarter last year, according to Voit.

Unfortunately, absorption can not put a dent in the standing inventory let alone the square footage under construction or planned construction.

In the second quarter, 203,500 square feet of office space was absorbed in San Diego County, according to Voit, compared to negative 191,300 square feet in the first quarter and 576,700 square feet in second quarter 2007.

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