The Recovery: Is it Real? San Diego Economic Conference, Commercial Real Estate Section

The Recovery: Is It R

eal? 2010 San Diego Econom

ic Forecast Conference Volu

me 4

• N

um

ber 2

M

ay 2

01

0

BEACONECONOMICS

Economic ForecastConference

2010 SAN DIEGOReal?Is It

RECOVERY:The

BEACONECONOMICS

Commercial Real Estateby Patrick S. DuffyMetroIntelligence Real Estate Advisors

ContentsKey Chapter Findings 86Overview 86The San Diego Office Market 87The San Diego Retail Market 90The San Diego Industrial Market 93Construction Trends 95

Commercial Real Estate Beacon Economics

Key Chapter Findings

As employers resist hiring new workers and the local economy remains perilous, the office market in SanDiego County will remain under pressure through the first part of 2012. Look for rents to fall by nearly6% by the end of 2010 as vacancies remain elevated at just over 19%.

Although the bulk of losses in the retail market here have already been realized, there is still more pain tocome before the bottom is reached. Look for asking rents to continue falling by another 2.6% by the endof 2010 as vacancies remain elevated, but should gradually trend downwards slowly as the year unfolds.

Given the somewhat tertiary nature of San Diego's industrial andwarehousemarket, the recovery for thissector will be slow and largely dependent on improvements in retail sales and household formations. Fornow, look for rents to fall by another 2.4% by the end of 2010 as vacancies remain stuck in the low doubledigits.

Overview

Following the collapse and carnage in the housingmarket, the commercial markets spent 2009 mostly ina state of suspended animation, while huge inflows offederal dollars prevented even larger carnage amongthe nation’s banks. In many respects, the day of reck-oning for commercial real estate has come in 2010, ayear that will continue to be characterized by write-downs, defaults, andworkouts as prices finally hit bot-tom. While “extend and pretend” policies will con-tinue to allow banks to avoid foreclosing on commer-cial property owners who are technically in default,there will still be an increase in the sale of distressedassets by both government regulators and financialinstitutions. As transaction volume increases from itsmoribund state, continued declines in value will ulti-mately averagemore than 40% since the peaks of mid-2007. For industry veterans, the current reversal willlikely be theworst of their careers—morenotable thanthe decline of the early 1990s (when overbuilding wasthe culprit) and the most painful since the Great De-pression.

Still, what feels like pain to sellers is an opportunityfor buyers, especially for those investors with cashwho are poised and ready to jump in at or near the

bottom. Cash will remain king because debt marketswill continue to be compromised, although there isa spring thaw emerging in those markets that didnot participate in the recent boom-and-bust cycle.While there has been some minimal movement inCMBS markets, the sheer complexity of the workoutsto come—especially given the increasing level of trou-bled loans maturing now through 2015—means thatrebuilding confidence in the model will take sometime.

Still, what feels like pain to sellers is anopportunity for buyers, especially for thoseinvestors with cash who are poised andready to jump in at or near the bottom.

In addition, given the slow pace of the economic re-covery, with anemic job growth and low levels of con-sumer spending, any resurgence in the commercialmarkets will likely be postponed until late 2011 or2012. For 2010, both rents and occupancies will con-tinue to fall, thereby putting additional pressure onowners striving to hang on.

Even though this latest cycle was not characterizedby overbuilding, the poor fundamentals have forcedcommercial developers into a sort of involuntary va-

86 2010 San Diego Economic Forecast Conference

Beacon Economics Commercial Real Estate

cation. Until values rise above replacement cost anddemand improves, it will continue to be extremely dif-ficult to obtain financing for new projects on any rea-sonable terms.

With retail properties suffering due to the profounddecline in consumer spending and office demandshrinking as companies resist new hires, pursue in-creased productivity, and seek lower-cost subleasespace, both the retail and office property sectors willtake longer to rebound than either the apartment orindustrial use sectors. But once hiring does rebound,the apartment sector (which is discussed in the resi-dential real estate section of this report) will recoveras “echo boomers” (the children of the baby boomers)tire of doubling up with roommates—or of living backhome with their families—and seek independence.

Nonetheless, as technology continues toallow workers to telecommute from

anywhere in the world, the traditional officewill likely come under increasing pressurefrom companies looking to shave their real

estate costs.

Look for these key trends in 2010:

Due to economic uncertainty, businesses will con-tinue being conservative with capital spending andexpansion, delaying such decisions until a reboundis evident (although health care will be an excep-tion).

Hiring will remain limited throughout the year,but given the extreme job cuts during this reces-sion—up to 8.4 million jobs—there could be a short-age of workers in many industries by 2011.

Althoughmore distressed propertieswill be offeredto the market, investors should not expect a waveof high-quality REO properties, as lenders will “ex-tend and pretend” in order to delay or avoid fore-closures, especially for those assets in prime loca-

tions and with reasonable expectations of stabiliz-ing.

Nonetheless, with over $800 billion in commercialmortgage debt maturing over the next two years,many ownerswon’t be able to roll this debt over, es-pecially in light of higher vacancy rates and lowerrents.

Given the ongoing caution by banks, alternativefinancing by life insurance companies and TALF-eligible CMBS could take up some, but certainly notall, of the slack in lending.

Tremendous opportunities abound for well-capitalized investors with the expertise to investcountercyclically in the best submarkets, partic-ularly investors with cash, given the uncertaintyregarding future interest rate hikes.

The San Diego Office Market

One of the most important advantages of the U.S.economy is that it continues to add to its demographicbase, thereby supporting the demand for office em-ployment, which will likely be strengthened as se-nior citizens, hit by the one-two punch of declininghome values and declining retirement portfolios, optto work longer.

Nonetheless, as technology continues to allow work-ers to telecommute from anywhere in the world, thetraditional office will likely come under increasingpressure from companies looking to shave their realestate costs. According to rough estimates from theTelework Research Network in San Diego, if the 40% ofthe workforce that could work from home decided todo so half of the time, American companies could saveup to $700 billion per year, including gains in produc-tivity, reduced expenses for office space and utilities,and reduced numbers of absent or quitting employees,the latter being those who might be tempted to stay ifallowed to telecommute.

2010 San Diego Economic Forecast Conference 87


One emerging compromise between true telecommut-ing and the traditional full-time office is the virtualoffice, in which workers—often small business own-ers—opt to share meeting and conference areas andcopy rooms with others, thereby achieving signifi-cant savings on long-term leases. Depending on theprovider, additional services might also include a re-ceptionist and shared administrative assistants. Withrents ranging from as little as $60 permonth for a sim-ple corporate address to nearly $650 per month foran office, at some buildings virtual office tenants arestarting to outnumber conventional ones. Althoughit is unlikely the trend in telecommuting and virtualoffices will dramatically impact office demand in theshort term, over the long term it could conceivablychange the way in which certain industries—and cer-tainly those which employ technology themost—viewthe traditional office.

…by 2013 about 1,000 federally run officeparks, labs, and other properties could start

subleasing space to private companies.

Another wildcard facing the national office market isa recent policy change by the White House instruct-ing federal agencies across the country to lease un-used space in their buildings to help cut the deficit.Although nearly 400 federal properties already leasespace to service providers, such as banks, restaurants,salons, and newsstands, by 2013 about 1,000 federallyrun office parks, labs, and other properties could startsubleasing space to private companies.

For now—at least in the San Diego area—office vacan-cies, as a lagging indicator,will likely increase throughthe end of the year, but clearly the worst damage tothe market happened in 2008 and 2009, with vacancyrates rising by nearly 40% between the first quartersof 2008 and 2010 alone. Throughout this downturn, ac-cording to Portfolio and Property Research (PPR), acombination of heavy job losses of office-using posi-tions and intense competition from cheaper sublease

space conspired to push vacancy rates up to nearly19% by the first quarter of 2010. By the second quar-ter of 2010, office vacancies are projected to peak at19.3%—close to what this market saw for much ofthe 1980s and early 1990s—but rates will begin to fallsteadily as the economy recovers. By the end of 2014,vacancies could fall to 13%, the same rate as in thefourth quarter of 2007 but still far above the mid tohigh single digits noted just after the turn of the cen-tury.

5

10

15

20

25

Perc

ent

Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09

San Diego (MSA) Los Angeles (MD)Inland Empire (MSA) Orange County (MD)

*These data are seasonally adjusted and smoothedSource: Property & Portfolio Research

Q1-90 to Q1-10Office Vacancy Rate

Not surprisingly, the rapid rise of these vacancy rateshas put tremendous pressure on average rental costs,which could bottom out at rates not seen since the1990s. By the first quarter of 2010, asking annual rentsfor office space had fallen to $22.98 per square foot inSan Diego—a decline of about 11% over the previousyear. Throughout 2010, rent declines are expected toslow but to still drop by another 2.3% owing to the lackof pricing power by landlords. From peak to troughduring this market correction, rents could fall by a cu-mulative 25%, as sublease space continues to competewith the direct space marketed by landlords through-out the region.

And yet there is light at the end of this tunnel, be-cause when the rebound does occur, it is expected tobe steady. Although annual rent growth will remainin low negative territory through the end of 2011, itshould turn positive by 2012 and exceed 1% per quar-



ter after the fourth quarter of 2012. Although askingrents are still projected to fall by nearly 6% by the endof 2010, by the end of 2014 they could rebound by justover 4%.

10

15

20

25

30

Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09



Q1-90 to Q1-10Office Cost of Rent

After remaining mostly flat throughout 2009 and into2010, the demand for office space is expected to grad-ually grow, starting in 2011. Between the first quar-ter of 2010 and the end of 2014, the demand for officespace is projected to rise by nearly 11%.

Between the first quarter of 2010 and the endof 2014, the demand for office space is

projected to rise by nearly 11%.

Given this moribund demand for office space, the netabsorption level for office space—which had turnedpositive by the end of 2009 after a disastrous 2008—isexpected to dip temporarily into negative territoryduring the second quarter of 2010 before reboundingby the third quarter. By the last half of 2012, quarterlyabsorption levels could approach 900,000 square feet,continuing to range above 800,000 square feet throughthe middle of 2013. Thereafter, net absorption willslowly decline as pent-up demand is met, with levelsrangingmostly from230,000 to 425,000 square feet perquarter throughout 2014.

-4,000

-2,000

0

2,000

4,000

Thou

sand

s of

Squ

are

Feet

Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09



Q1-90 to Q1-10Office Net Absorption

Fortunately for investors, one important side effect ofthe changing fundamentals has been a commensuraterise in cap rates. Although cap rates fell below 6% dur-ing the last half of 2005 and through the first half of2007, rates have since rebounded strongly to average8.6% by the first quarter of 2010. They are projected toapproach 8.8% by the last quarter of 2010. Althoughcap rates in the office sector could exceed 9% by theend of 2011, from then until the fourth quarter of 2014they will slowly drift downward toward 8%.

6

7

8

9

10

Perc

ent

Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09



Q1-90 to Q1-10Office Cap Rates

To be sure, in a county as diversified as San Diego,some office submarkets have performed better thanothers. According to surveys by PPR, the highest va-cancy rates at the beginning of 2010 were seen in theSouth County (30.3%) and the North County (24.7%),



San Diego Office Characteristics by Submarket (Q4-09)

Submarket Vacancy Rent Rent Growth Total Stock Stock Change Absorption ChangeRate (%) $/SF/Year Q-o-Q (%) SF (000) SF (000) SF (000)

CBD 16.2 24.04 −3.1 17, 062 0 −136I-15 Corridor 23.6 21.59 −3.7 16, 583 445 421I-5 Corridor 18.5 28.07 −3.3 50, 027 0 −300Mission Valley/North Central 15.2 26.41 −2.3 15, 878 20 144North County 23.7 23.95 −2.3 9, 735 33 64South County 30.5 21.21 −0.9 2, 014 0 −8Metrowide 19.1 25.55 −3.0 111, 617 498 185

Source: PPR

with the lowest rates noted in Mission Valley (15.8%)and downtown (16.8%). Similarly, the cheapest officespace is currently found in the South Bay area ($20.79per square foot per year) as well as the I-15 corridor($21.15 per year).

Looking ahead to the rest of 2010 through 2012, thehealth of the office market will be largely tied to theextent of increased government spending on biotechand technology. Although any spending related to de-fense is at risk, given the rising federal debt, the lat-est proposed budget from Secretary of Defense RobertGates seems to bode well for the region’s many high-tech companies focused on defense, such as GeneralDynamics and General Atomics.

Yet, when the rebound for the office marketdoes occur in San Diego, it’s expected to bequite robust given the rise in cap rates andthe decline in values, thereby making thecounty attractive to outside investors.

Nonetheless, if a larger-than-expected share of dol-lars from the stimulus package and the National Insti-tutes of Health bypasses San Diego in favor of othermarkets, then local companies will instead have torely on outside sources of capital for new high-tech orbiotech companies and products. This type of uncer-tainty makes it more difficult to predict the sector’sdynamics now through mid-decade.

Yet, when the rebound for the office market does oc-cur in San Diego, it’s expected to be quite robust giventhe rise in cap rates and the decline in values, therebymaking the county attractive to outside investors. Bythe end of 2014, office space values are still expectedto be 36% below their peak levels. So, what couldspell bad news for underwater landlords hoping to bemade whole sooner rather than later is still good newsfor both new investors and tenants. Moreover, overthe long term San Diego’s strong employment base inprofessional, scientific, and technical services puts itsmack in the middle of the country’s future drivers ofgrowth.

The San Diego Retail Market

The national retail sector is looking a bit stronger incomparison with the bloodbath of the last two years,but the economic vacancy rate—which takes into ac-count both free space included with concessions andsub-lease space, making it a longer number than thespace available for rent directly from landlords—willcontinue to rise before peaking at the end of 2010.To be sure, the recession in the retail sector was theworst in memory, with more than 19% of national re-tail space technically unsupported by traditional eco-nomic fundamentals, leading to space giveaways andother concessions.



Although retail sales in March 2010 rose by 9.1%over the same month of 2009—thereby posting thestrongest gain in a decade—analysts caution that anearly Easter, pent-up demand, and warm weather donot necessarily add up to a long-term trend. How-ever, for now the rise in discretionary purchases andthe strength of both middle-market retailers (such asMacy’s, Target, Gap Inc., and Kohl’s) as well as pur-veyors of luxury goods (such as Saks Inc.) could meanthat the long-awaited rebound for the retail sector isfinally underway. And even as some well-known re-tailers have closed underperforming stores or filed forbankruptcy protection, a small number of nimble re-tailers—such as discount clothiers H&M and Forever21, as well as Trader Joe’s quasi-competitor Fresh &Easy—have actually managed to expand throughoutthe downturn.

Those few projects that will be able to pushforward this year will mostly be standalone,big-box retailers, such as Wal-Mart andwarehouse clubs, as well as some strong

grocery and drug store companieslooking to expand.

In addition, the dearth of new retail construction inmost markets will undoubtedly support the strengthof the rebound,withmore sustained improvements by2011 and the most dynamic recoveries noted in thosehigh-growth metropolitan areas that were groundzero for the housing bust. Yet for the remainder of2010, any gains in tenancy will most likely come bystealing market share from other centers rather thanfrom organic growth. Those few projects that will beable to push forward this year will mostly be stan-dalone, big-box retailers, such as Wal-Mart and ware-house clubs, as well as some strong grocery and drugstore companies looking to expand. What we won’tsee a lot of this year will be those types of projectsthat characterized the boom years, namely big-box

power centers, outdoor lifestyle centers, and mixed-use projects.

In San Diego County, due to a combination of weak-ening fundamentals, closed lending markets, and acurrent aversion to the sector, the local retail mar-ket remains amess, characterized by plummeting val-ues but rising cap rates to compensate for the addedrisk. It certainly hasn’t helped that the closings ofchains such as Home Depot Expo, Circuit City, Linens‘N Things, and Steve & Barry’s have dumped hundredsof thousands of square feet of space onto the marketwhen there are few tenants able or willing to step in totake up the slack. Even when the market begins to re-bound—toward mid-decade—developers will want tostart building again, which could limit the strength ofthe recovery for existing stores.

According to PPR, economic vacancy rates seem tohave peaked at just under 11% during the first quar-ter of 2010, after rising fivefold since the third quar-ter of 2006. Over the last two years alone, retail va-cancy rates have risen by over 220%, and they aren’texpected to start trending downward until the secondquarter of 2010. From 2010 until the middle of 2012,look for economic vacancy rates to exceed 10% butthen gradually fall to just over 8.5% throughout 2014.

However, according to brokerage CB Richard Ellis thepercent of vacant retail space available for rent di-rectly from landlords— not including sub-lease spacefrom existing tenants—averaged 6.2% during the firstquarter of 2010. although they are up from 4.2% dur-ing the same period of 2009, direct vacancies netof concessions are down slightly from the 6.4% ratenoted in the fourth quarter of 2009.



As the economic recovery gains momentum, look for the net absorption of retail spaceto exceed 500,000 square feet per quarter by the second quarter of 2012, with levelsremaining elevated for another year. Thereafter, as pent-up demand is sated,quarterly absorption could gradually decline to about 360,000 square feet per quarterby the last quarter of 2014.

0

5

10

15

20

25

Perc

ent

Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09



Q1-90 to Q1-10Retail Vacancy Rate

In addition to being undercut by rent concessions,which are often difficult to track quantitatively, ask-ing rents per square foot in San Diego are also feel-ing the impact of a slowing economy, falling by nearly10% over the last year to $20.97 per square foot annu-ally. Although retail rents are projected to continuefalling by another 2.6% and reach a cyclical trough of$20.42 per square foot by the end of 2010, thereafterthey will continue to slowly recover, posting annualrent growth ofmostly 0.4% to 1.0%. By the end of 2014,annual retail rents could exceed $22.75 per square footand climb by 8.5% over rents posted in the first quar-ter of 2010.

By the end of 2014, annual retail rents couldexceed $22.75 per square foot and climb by

8.5% over rents posted in the firstquarter of 2010.

10

15

20

25

30

Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09



Q1-90 to Q1-10Retail Cost of Rent

Not surprisingly, due to the rapid decline in consumerspending at retail stores during the recession, the netabsorption of retail space turned strongly negative inthe last half of 2008 through the middle of 2009, withspace givebacks approaching 5.5 million square feet.More recently, losses have ranged from 400,000 to onemillion square feet per quarter through the last halfof 2009 and into the first quarter of 2010. PPR is pro-jecting an end to these space givebacks in favor of asmall yet positive rebound of 84,000 square feet bythe second quarter of 2010. As the economic recov-ery gains momentum, look for the net absorption ofretail space to exceed 500,000 square feet per quarterby the second quarter of 2012, with levels remainingelevated for another year. Thereafter, as pent-up de-mand is sated, quarterly absorption could graduallydecline to about 360,000 square feet per quarter by thelast quarter of 2014.



-4,000

-2,000

0

2,000

4,000

Thou

sand

s of

Squ

are

Feet

Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09



Q1-90 to Q1-10Retail Net Absorption

As in the officemarket, one benefit of the changing dy-namics of the retail sector has been a slow yet steadyrise in cap rates. After falling to less than 5.6% fromthe end of 2005 through the third quarter of 2007, caprates hit 8.0% by the third quarter of 2009 and rose to8.15% during the first quarter of 2010. Although caprates are expected to continue falling due to increas-ing competition for retail properties, rates will con-tinue to stay above 8.0% through the end of 2014. From2011 through 2014, they should continue to declineslowly yet stay above 7.40% through most of 2014.

5

6

7

8

9

Perc

ent

Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09



Q1-90 to Q1-10Retail Cap Rates

Looking ahead for the rest of 2010, even though thereare certainly pockets of wealth throughout San DiegoCounty, the collapse in both the stock market and thehousing market has affected retail spending across allincome levels. With thrift now the mantra in many

U.S. households, a recent Gallup poll showed that eventhose households earning more than $90,000 have cuttheir daily spending by nearly 40%, which has un-doubtedly hit the retail sector. For the foreseeable fu-ture, any growth in retail sales will be driven strictlyby fundamentals, such as population growth and in-creases in income, rather than benefits from any per-ceived wealth effects.

As in the office market, one benefit of thechanging dynamics of the retail sector hasbeen a slow yet steady rise in cap rates.

Although the retail sector is expected to recovernicely once the larger economy gains strength, thesector could still be vulnerable in the event of a morepronounced downturn or a double dip, or if the paceof economic growth turns out to be much slower thananticipated. Consequently, look for both lenders andtenants to be squeamish on new retail space until it’sbecome quite evident that the economic fundamen-tals are in full support.

The San Diego Industrial Market

Of the various commercial real estate sectors ad-dressed in this report, the industrial sector will be thefirst to recover, with a projected end to rising vacan-cies during the first quarter of 2010. Although demandfor new industrial space will be constrained due tothe larger economic issues of lower retail sales and re-duced global trade, short lead times for new projectshave meant a virtual shutdown of additional supplynationally. On a national scale, economic vacanciesfor industrial space will improve modestly, decliningfrom 13.2% in the first quarter of 2010 to 12.9% bythe end of the year, compared to the continued in-creases among other commercial sectors. With bothlenders and developers holding the line on new con-struction until economic fundamentals no longer hint



at the possibility of a double dip, vacancies are pro-jected to continue falling to under 9% by the end of2014, after which supply will gear up tomeet the pent-up demand.

For the San Diego County region, because its ware-houses function mostly as distribution points for thelocal population, future demand is dependent uponincreases in population and retail demand. Moreover,given the preference by national distributors to serveSan Diego County from either Los Angeles or thelower-cost Inland Empire, local landlords will con-tinue to struggle to fully lease larger industrial spaces.Moreover, although San Diego does have an excellent

Accompanying the 51% increase in thevacancy rate over the past two years was adecline of 12.8% in asking rents, to $6.86 per

square foot annually.

port, its reliance on the military and on the cruiseship industry has helped to divert traffic to the twinports of Los Angeles and Long Beach. Although SanDiego’s industrial sector will be the quickest out of thegate compared to the recovery in the retail and of-fice space markets, the recovery will still take sometime because of San Diego’s relatively small industrialbase—especially for warehouses.

For most of the first decade of the 21st century, indus-trial space vacancies countywide ranged from 7.0% to9.0%, not surpassing the 10% mark until the middle of2009. Since then, vacancies have continued to climbslowly, hitting 12.4% by the first quarter of 2010. For-tunately, that will likely be the peak for this cycle, andindustrial vacancies should continue falling by 8.0%by the end of 2014 to average 11.4%. Thereafter, va-cancies should slowly continue declining, falling be-low 10% in the first quarter of 2012 and by nearly 26%to average 9.2% by the fourth quarter of 2014. Notably,given the 10.5% direct vacancy rate reported by bro-kerage CB Richard Ellis for the first quarter of 2010, by

the end of 2014 direct vacancies will likely be closer to7.0%.

0

5

10

15

20

Perc

ent

Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09



Q1-90 to Q1-10Industrial Vacancy Rate

Accompanying the 51% increase in the vacancy rateover the past two years was a decline of 12.8% in ask-ing rents, to $6.86 per square foot annually. Sincerents tend to decline for several quarters even aftervacancies have bottomed out, look for small yet con-tinuing declines, to about $6.70 per square foot bythe fourth quarter of 2010. Thereafter, asking rentsshould slowly start to rise, hitting $7.00 by the thirdquarter of 2012, and should continue to rise to end2014 at $7.63 per square foot—a gain of 11.2% from thefirst quarter of 2010.

4

5

6

7

8

Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09



Q1-90 to Q1-10Industrial Cost of Rent

Absorption levels, which briefly dipped into negativeterritory in early 2007 after years of ranging up to asmuch as 500,000 square feet or more per quarter, fell



exponentially, starting in the last half of 2008, withover 900,000 square feet of space given back in the sec-ond quarter of 2009 alone. Although these space give-backs did decline to just over 225,000 square feet bythe first quarter of 2010, starting in the second quar-ter of 2010 net absorption levels are expected to re-bound into positive territory. Thereafter and throughthe rest of 2010, absorption is expected to range from217,000 to 255,000 square feet per quarter. But for2012, absorption of industrial space should increasenotably, ranging from 300,000 to 350,000 square feetper quarter. After pent-up demand has been met,however, throughout 2013 and 2014 this absorptionshould settle back down to range mostly from 200,000to 250,000 square feet per quarter.

-4,000

-2,000

0

2,000

4,000

6,000

Thou

sand

s of

Squ

are

Feet

Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09



Q1-90 to Q1-10Industrial Net Absorption

Cap rates for industrial properties, which had consis-tently ranged from just 5.7% to 6.9% during 2006 and2007, rapidly rose to approach 8.5% by the first quar-ter of 2010 as the sector’s fundamentals changed. Be-tween the first quarters of 2008 and 2010, cap ratesrose by 39%, increasing by 19% since the first quar-ter of 2009 alone. Through the end of 2010, cap ratesare projected to remain flat, peaking at 8.58% by thefourth quarter, afterwhich they’ll gradually fall to justunder 8% by the middle of 2014 as more investors en-ter the marketplace.

5

6

7

8

9

Perc

ent

Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09



Q1-90 to Q1-10Industrial Cap Rates

Looking ahead, the largest issue impacting the indus-trial sector in San Diego will be the recovery of the lo-cal economy. With its locally driven warehouse mar-ket and manufacturing base oriented mostly towardbiotech and high-tech components, any rebound willbe reliant upon the housing market stabilizing, jobgrowth resuming, and the county receiving its histor-ical share of defense and military spending.

Through the end of 2010, cap rates areprojected to remain flat, peaking at 8.58% by

the fourth quarter, after which they’llgradually fall to just under 8% by the middle

of 2014 as more investors enter themarketplace.

Construction Trends

According to the Construction Industry ResearchBoard about $1.5 billion in new nonresidential de-velopment was permitted in 2009 for San DiegoCounty—a decline of 37% from 2009 and 52% from2007. During the first quarter of 2010 alone, $395 mil-lion in new nonresidential development was permit-ted, down only 4.3% from the same quarter of 2009.

Not surprisingly, the annual decline between 2008 and2009 was much more pronounced for new office de-



velopment, falling by 82% versus declines of 68% forretail uses and 64% in the industrial sector. However,when comparing the first quarter of 2010 to the samequarter of 2009, office building permits rebounded bynearly 11%, while sharp declines continued for boththe retail sector (41%) and industrial sector (56%).

Interestingly, other sectors of commercial develop-ment in 2009—mostly additions to existing struc-tures—fell by a relatively modest 31% from 2008 andby 33% from2007. At the same time, non-core develop-ment in 2009 (including parking garages and servicestations, as well as amusement and recreation uses)also fell from both 2007 (58%) and 2008 (32%) levels.Given the weakness of the underlying economic fun-damentals for commercial real estate, we don’t expectthe value of new commercial permits to begin risingagain on a sustained basis until a stronger rebound isevident, excess space has been absorbed and rents areon the rebound.

Non-Residential Building Permits by ValueSan Diego County, Millions of DollarsCategory 2007 2008 2009

Alterations 89.8 92.4 62.4

Garage 18.0 6.1 6.1

Industrial 26.2 16.3 4.5

Office 42.5 50.0 4.4

Service 0.0 0.3 0.2

Store 16.9 17.3 9.1

Other 32.4 22.6 31.4

Total 225.7 205.0 118.1

Source: Construction Industry Research Board

40

60

80

100

120

140

Mil

lion

s of

Dol

lars

(SA

)

Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09Source: Construction Industry Research Board

San Diego County, Jan-95 to Mar-10Value of Total Non-Residential Permits


Documents

The Recovery: Is it Real? San Diego Economic Conference, Commercial Real Estate Section