San Diego Office Glut Is Good News for Tenants : Rents: Brokers offer big discounts in effort to fill buildings, but they expect the situation to change.

The San Diego office market is generally overbuilt, which may be bad news for the developers stuck with largely empty buildings but good news for local tenants who are being offered big discounts as inducements to sign leases.

But local brokers and developers expect the oversupply to shrink over the longer term as construction slows. They attribute the downturn in new building to the scarcity and high cost of construction financing and the cautious approach that Japanese investors are now taking in buying U.S. real estate.

San Diego is no different from most other U.S. metropolitan markets with its glut of office buildings, according to Kraig Kristofferson, a broker with Coldwell Banker’s downtown San Diego office. He said the countywide vacancy rate is now about 20%.

The picture is worse in suburban markets such as Mission Valley at 24% vacant and the University Town Centre area at 29% vacant. Office building owners are typically offering discounts of 25% or more on leases to prospective tenants, said Dennis Cruzan, a partner in CentreMark, a San Diego-based development firm.

Over the next year, three new downtown office buildings totaling 1 million square feet of leaseable space will be completed, an 18% addition to downtown’s total office square footage, Kristofferson said. But the addition may not affect downtown’s current 14% vacancy rate as much as one might think because the new crop of buildings is already 75% to 80% leased, he said.

The supply of available industrial and retail building space in San Diego is much less glutted than offices, although leasing of new retail buildings has slowed to the point that brokers expect an oversupply to develop in coming months.

Industrial and warehouse buildings, countywide, feature an overall vacancy rate of 12%, with vacancies much slimmer close to the city’s center. Coldwell Banker industrial space specialist Bill Haines credits strong job growth and the increasingly diverse San Diego economy for the strong demand.

Most completed retail centers in San Diego County are virtually leased up, averaging vacancies of 5% to 8%, said Don Moser, a retail space specialist with Coldwell Banker’s downtown San Diego office. But the figure is somewhat misleading: new retail centers now under construction have been slow to attract tenants, Moser said.

“The (retail) market place has slowed down significantly, and it’s shifted to a tenant’s market,” Moser said. “One of the main themes in the market place is that retailers are feeling a lack of confidence in consumer spending. So they are taking the same wait-and-see attitude on (leasing) new locations.”

Although larger retail tenants are still in the market shopping for prime locations, smaller independent retailers have slowed their expansion plans, Moser said.

Although there is now an overall glut of commercial real estate in the county, many local real estate brokers and developers predict the supply of available commercial space will shrink dramatically over the next year or two. That’s because the overall pace of development of new buildings in San Diego has slowed considerably in recent months.

Several reasons for the slowdown are cited. Probably the largest single factor is the wholesale departure of savings and loans from the construction lending business, a flight caused by provisions in the S&L; rescue bill passed last summer that made commercial real estate loans and development less profitable.

Until the S&L; crisis forced most of them from the arena, S&Ls; financed 60% to 65% of commercial real estate transactions “one way or the other, through joint ventures or mortgage financing or both,” said Coldwell Banker’s Haines. Tighter regulatory requirements have now taken S&Ls; out of the game, leaving a significant void.

Another dampener in San Diego is the expectation that the city may soon impose significant increases in development fees as a way of raising money to help the city out of its budgetary crisis.

Mike Smith, a broker with John Burnham & Co.’s downtown San Diego office who specializes in land and industrial properties, said one city proposal would boost fees to an average cost to the developer of $12 per square foot developed from the current $3 per square foot. If passed, the fee increase would make many projects now being planned economically unviable.

“A lot of developers within San Diego are holding off on new projects to see if there will be any increase in building fees. If that’s the case, there may not be any development taking place. It will flat put a lot of developers out of business,” Smith said.

Kristofferson said another factor in the building slowdown is that Japanese investors and lenders are not as eager to invest in San Diego projects as in the past.

“The interest rates in Japan have risen to where there isn’t the spread between rates there and (interest rates) in the U.S. So there is less inducement to make loans over here,” Kristofferson said. “They are not as aggressive as they have been.”