Mind the Gap: San Diego’s Skyline Office Rental Rates Continue to Rise

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There’s no space like Skyline space. The premier office towers that make up San Diego’s skyline boast—by far—the most expensive office space to rent downtown, garnering 10.1 percent more than non-Skyline space, according to JLL’s 2015 Skyline Review. Average Skyline rates in the first quarter of 2015 were $29.66 per square foot compared to $26.94 per square foot in non-Skyline buildings downtown. This gap between Skyline and non-Skyline space represents a notable shift from historical spreads: 10 years ago, the difference was just 6.1 percent.

“The flight to quality in earlier recovery years coupled with an improving economy today have led to significant supply constraints in the country’s highest-quality office buildings, and the rent gap has widened significantly,” said Bess Wakeman, executive vice president at JLL in San Diego.

Unlike many cities, however, some San Diego suburban sub markets continue to command higher office lease rates than downtown, including Carlsbad, Del Mar Heights, Rancho Bernardo, Sorrento Mesa, Torrey Pines, UTC and Mission Valley. As compared to just San Diego’s downtown skyline buildings, however, only Del Mar Heights, Sorrento Mesa, Torrey Pines, and UTC still command higher lease rates.

Nearly three-quarters (75 percent) of the new development nationwide is concentrated in only nine cities, which means most tenants will have little negotiating leverage in their office agreements for the time being, including those in San Diego. Downtown San Diego does, however, have several major office construction projects pending, and if lease rates continue to climb, those developers will be able to justify new construction costs.

JLL’s proprietary 2015 Skyline Review identifies and tracks micro-segments of 47 city centers across North America.  The Skyline features Trophy, Class A and Class B buildings where tenants and investors alike focus demand for office space in a flight to quality and efficiency.

A diminishing “home-team” advantage 

If office rental rates are fierce, the price tag to buy an office building is even more so. Economic growth, business expansion and improving market fundamentals have resulted in year-over-year pricing gains of plus-10 percent, pushing San Diego’s Skyline buildings closer to peak prices.

The sheer volume of foreign capital chasing Skyline office deals is having a major impact on pricing. Of the $35.3 billion transacted over the past five quarters across the U.S., 34.6 percent was driven by international buyers. In Houston and Seattle, every office deal transacted during this time period had a foreign buyer, while in Washington, D.C., Boston and New York, offshore capital led more than 50 percent of office purchases. During 2014, four international buyers entered the San Diego market – one from Turkey, two from Canada and one from Mexico – but the acquisitions were made countywide and not in the skyline.

Nationwide, however, “International capital is making a long-term impression on the U.S. Skyline.  We predict foreign buyers to invest $50 billion into U.S. commercial real estate in 2015, and they appear to be buying for the duration.  This will have a major impact on future Skyline liquidity, particularly for Trophy assets in primary markets, where more than half of foreign capital is being invested,” said Steve Collins, international director with JLL’s Capital Markets.

Unlike the large gateway cities of New York, Chicago and San Francisco, foreign investment does not play much of a part in San Diego’s landscape of major commercial real estate assets. “The size of investment in San Diego tends to be less than $100 million,” said Bob Prendergast, Managing Director for JLL’s San Diego capital markets team. “Many of the international investors are looking to invest larger sums of money and the majority of the individual property sales in San Diego are less than $50 million, making it less efficient to deploy larger sums of capital.”

“The pace of investing in San Diego, however, has remained consistent year-over-year from 2014 into 2015, and sentiment remains very positive” added Lynn LaChapelle, Managing Director, JLL San Diego capital markets team.

A redefined Skyline 

As investors begin to diversify beyond the Trophies for investment opportunities, a growing segment of tenants are also turning away from Skyline buildings in favor of non-core Class A and Class B buildings, inside and outside of traditional Central Business Districts. The perception of an “address” has been replaced by the desire for highly customized office space, particularly among fast growing tech and other creative companies.

But the trend does not stop there: today, many companies are trying to mimic tech whether through business strategy, people strategy or even real estate strategy. The growing millennial workforce and their employers are increasingly drawn to architecturally significant Class B buildings located in dense neighborhoods packed with amenities.

“Tech users and other creative firms want unique space – they’re mostly indifferent to building quality as long as they are able to design attractive, creative environments with easy access to amenities like coffee houses and gyms to support employee retention and recruitment,” said Joe Bernstein, senior vice president with JLL’s tenant representation group. “Also of note, companies across all industry sectors, not just tech, are all looking to conserve their footprint and utilize technology to drive greater collaboration, which equates to increased productivity.

Steve Holland, managing director with JLL’s tenant representation group, added, “A lot of these B-buildings gaining favour are on the perimeter of the traditional high-rise central business districts in areas that have more of a neighborhood feel. In turn, they like the idea of adaptive reuse and contributing to neighborhood revitalization. As the gap between Skyline and non-Skyline space continues to grow over the short-term, we actually could be reaching a peak inflection point based on future demand patterns favoring amenity-rich space over building.”

About the Skyline Review

For the first time, investors and tenants alike can now access JLL’s Skyline Review via a digital platform.  The fully interactive website will feature JLL’s proprietary national data insights regarding office supply, demand, rents, leverage and investment into 47 markets across the United States and Canada, with the ability to compare and contrast individual markets or multiples of markets.  In addition, the site will offer videos and infographics. All data will also be available via mobile access.  Users can also directly access information about San Diego’s Skyline.

Post this: What’s your skyline’s story? #JLLSkyline is out and features the latest office sector trends to help #investors and #tenants make informed decisions. Visit the new JLL digital Skyline here. Share on LinkedIn

Click to Tweet:  Had a chance to check out the #JLLSkyline?  Learn more about the themes that shape today’s #office market. #SanDiego http://ctt.ec/cK5vP

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