Most leasing due to tenant shuffling; but some positive absorption seen

By some accounts, the office market in San Diego County and elsewhere is on the mend, by others, there is a lot of moving around without much growth.

CoStar reported that the downtown San Diego submarket returned 115,604 square feet during the first three quarters of the year. By that research firm’s accounts, there was some 2.05 million square feet of vacant office space in the downtown market as of Sept. 30, and while there has been a lot of movement, most tenants are just upgrading their space.

"There has been quite a bit of shuffling of the deck," said Stacy Meronoff, a CB Richard Ellis senior associate.

A Cassidy Turley BRE Commercial report seems to share this sentiment.

"Class A office space will remain in demand as flight-to-quality and renewals will continue to account for the most leasing activity," Cassidy Turley writes. "Expect to see more creativity and flexibility in lease terms as well as a continued pressure on asking and effective rents due to intense competition from landlords attempting to stabilize their existing tenant base and maintain occupancy."

"Were still seeing a lot of flight to quality," said Justin Halenza, a Cassidy Turley BRE office broker. "Most of this is lateral movement ... "We're not going to see any big positive gains for the next few quarters."

That said, Halenza noted that by Cassidy Turley's assessment, a net 442,635 square feet of office space was absorbed in the county through the first nine months of the year. That would only put it behind Oakland/East Bay at 708,000 and Seattle with a net 573,000 square feet. A CoStar report concluded the market here actually absorbed a net 432,900 square feet in the third quarter alone.

While these gains are significantly stronger than they were a year ago, more often than not, tenants are still simply going from building to building.

CoStar noted that the law firm of Procopio Cory Hargreaves & Savitch has moved into 100,522 square feet at 525 B St., but Meronoff noted that the firm vacated about 90,000 square feet at 530 B St. in the process.

While downtown San Diego may have more than 2 million square feet of vacant office space, Meronoff said it will get absorbed in time.

"As things start to get better, tenants will want to be in downtown. It's a little bit stagnant right now, however," Meronoff said.

Meronoff noted that the Bailey Gardiner public relations and advertising firm moved out of about 9,500 square feet in Hillcrest to go into a similarly sized space at 444 W. Beech St. downtown.

Outside of downtown, Nokia (NYSE: NOK) is in the process of moving out of 325,000 square feet at Scripps Northridge so it can occupy a reduced 196,734-square-foot space at The Summit in Rancho Bernardo.

CoStar notes that other tenants making moves include MedImpact Healthcare Systems Inc., which is moving out of 117,961 square feet at 10680 Treena St. in the Scripps Ranch area but will still maintain offices at that location.

Other tenants making such moves include CareFusion, which is moving into 95,731 square feet at 9868 Scranton Road in Sorrento Mesa from Torrey Pines.

"This trend will continue through 2010 and 2011," Cassidy Turley writes.

Halenza said this trend has been the case in more outlying markets as well. He said Carlsbad is another market where a flight to higher quality space is making it uncomfortable for landlords left holding the bag.

This translates to about a 29 percent direct office vacancy and a 31.4 percent overall vacancy in Carlsbad, according to Halenza. That represents 1.26 million of available space.

"The good news for Carlsbad is it's not getting any worse," Halenza added.

Such changes aren't exclusively the province of the office market. Depending on location, retail spaces have seen even more turnover during the past year. Gone are Mervyn's, Circuit City, Linen's 'N Things and Hollywood Video, and Blockbuster is on the brink.

Large spaces are getting refilled. In one Carmel Mountain Ranch shopping center, for example, the Circuit City became a Sprouts Market and the Linen's 'N Things became a Best Buy, but the old Mervyn's space has proven stubbornly difficult to re-lease.

Gregory Albertini, a Grubb & Ellis senior vice president, said when large retailers fail, it may be bad for a center in the short-term, but most of the spaces do get refilled relatively quickly.

"When you see these retailers failing, others such as Kohl's, Best Buy and Dollar Tree come in because they see the opportunity," Albertini said.