A Phoenix by the Bay
Downtown San Diego suffered horribly during the 1990s real estate slump when the economic slowdown produced by savings and loan failures and defense cutbacks made the inner city seem as though a neutron bomb had hit.
But the bay-side city has recovered so sharply in the last two years that real estate brokers are starting to speak in superlatives again. They’re even talking of a time in the not too distant future when San Diego’s central city will achieve something that has always eluded downtown Los Angeles--status as a bustling 24-hour city.
“It’s bouncing back like a bungee cord,” said broker Tim Cowden of Grubb & Ellis Co.
The image is apt because the city’s office market had to plunge to rock bottom before its recovery could start. How far it plummeted is illustrated by the quickly rising prices being paid today for buildings, which were practically being given away just a few years ago.
For example, an investment group called Southwest Value Partners bought a high-rise as recently as 1995 for the remarkably low price of $14 per square foot, said Jason Hughes, president of San Diego-based Irving Hughes Group Inc. Even more remarkable, the 22-year-old Comerica Bank building was in good condition, said Hughes, who represented Southwest Value in the deal.
By early last year, when Southwest bought the fourth downtown high-rise in a portfolio it has now placed on the market, it paid $127 per square foot. Hughes and other brokers say top-tier office buildings on the market today will likely fetch $200 or more per square foot in upcoming deals.
Besides the general economic slump and defense-industry downsizing that crippled the wider Southern California office market, San Diego had to cope with the collapse of the local savings-and-loan industry. San Diego-based S&Ls;, including HomeFed, Great American, Imperial and Central, once occupied more than a quarter of the downtown office space.
Banks and S&Ls; now represent only 4% of the downtown market. In their place, new tenants have appeared such as Golden Eagle Insurance Corp., which is consolidating several suburban offices into 180,000 square feet.
Brokers say Golden Eagle couldn’t have found a block of space that large in nearby suburban markets, where vacancy rates are in the 5% range. Those tight suburban markets are one reason downtown is bouncing back.
“If you’re a tenant looking for 20,000 square feet of space, you only have one choice in University Town Center and a couple in Mission Valley, but you have a dozen downtown,” Cowden said.
The downtown vacancy rate is considerably higher than that of the suburbs--it stands between 13% and 18%, depending on which properties are evaluated, said Lynn LaChapelle, a senior vice president with San Diego-based John Burnham & Co., a commercial real estate brokerage.
“The investment people like to exclude the lower-quality buildings because it makes a better picture,” she explained.
But even at its perceived worst, LaChapelle said, downtown is recovering quickly and it is more of a landlord’s market than statistics might suggest. The vacancy rate is well under 10% in the city’s five newest high-rises, built between 1989 and 1991.
Another sign of the recovery is the accelerating pace of sales.
“Hardly any high-rise buildings sold down here for years, then about nine of them have traded within the past two years,” said Kraig Kristofferson, a senior vice president with CB Commercial Real Estate Group.
What all this means, LaChapelle said, is that although the downtown market hasn’t quite recovered, it’s on the verge of a comeback that has immense potential. It also involves plans for more housing, hotels, a possible expansion of the Convention Center and maybe a new ballpark.
But for now rents are still lower than those in the suburbs. LaChapelle said top-quality space goes for $27 to $30 per square foot a year in the most popular suburban buildings, compared with $24 and less downtown. And even if they sell for $200 a square foot, she said, top-quality office buildings will still be traded for prices considerably below the costs of building new ones.
“Downtown is still a good deal compared with the suburbs,” LaChapelle said, “but it isn’t quite the good deal it was a couple of years ago.”
Despite the gap, LaChapelle and other brokers say the downtown market is poised for a boost from a host of new development projects--either existing, planned or underway--that will give urban San Diego a critical mass it has heretofore lacked.
“People now think of downtown as fun, whereas it was a ghost town 10 years ago,” Cowden said.
Downtown devotees say the city is in the midst of a renaissance powered by the Horton Plaza shopping center, the Gaslamp Quarter rife with restaurants and shops, two new movie-theater complexes with 27 screens, a proposed expansion of the waterfront Convention Center, including plans for new hotels, and a possible new baseball stadium for the Padres.
The Convention Center and baseball stadium projects hinge on voter approval in June, but brokers say the city has considerable appeal even without them. Development that has already taken place has reminded office tenants and downtown residents of charms that the city has always offered.
The downtown area opens to views of San Diego Bay and Balboa Park and draws cooling breezes. The newer office towers feature views that tenants will dig deep to pay for, and the city’s growing appeal to residential dwellers is evidenced by luxury high-rise condominiums and an apartment vacancy rate under 1%.
Kristofferson says he knows people who like downtown living so much, they commute to suburban jobs.
People in the real estate industry believe these factors and others, such as the increasingly popular mass-transit system, augur well for downtown’s office market. They signal that downtown San Diego is on its way to becoming a ‘round-the-clock district with quality housing, shops, restaurants and entertainment.
“We’re not quite a 24-hour city yet, but we’re close to getting there,” LaChapelle said.
An architect and planner by training, LaChapelle explained that current thinking among urban planners is that downtowns can move ahead by taking a step back.
“We’re returning to the idea that downtowns are places to live and have fun, not just places to work,” she said.
Investors, too, embrace the idea. Kristofferson said earning that reputation would be a big plus for San Diego’s office market. One of the first questions institutional investors ask when considering an urban property is: “Is it a 24-hour city?”
Investors, he explained, believe downtowns are a better bet when they have more to offer than fancy office towers, no matter how polished the marble.
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The Rise and Fall and Rise of an Office Market
Vacany rate in downtown San Diego office buildings:
1998: 15%*
*Estimate
Source: Federal Reserve Board
