Market Report: San Diego Industrial - First Quarter 2022

 
 

With the first quarter of 2022 in the books, the industrial sector has continued to surge, similar to what we saw in the second half of 2021. Inventory has remained extremely limited, on both the leasing and sales fronts. With inflation running rampant, we have seen an aggressive increase in interest rates, including a half point raise from the Fed this morning. Increased rates has the potential to cool down this scorching market if they continue throughout this year.

Vacancy for industrial properties in San Diego has continued to remain tight. We are now at an estimated 2.1% vacancy, which has driven up leasing rates. The lack of inventory is also the common theme for properties on the market for sale. The average sale price for an industrial building is at all time highs and approximately 30% higher since the start of 2021.

Something to keep an eye on is the rapid increases in interest rates. Just in the past 30 days, we have seen SBA loan quotes jump approximately 100 basis points to a rate of 4.68%. Conventional interest rates can vary anywhere from 4-4.5% depending on leverage and strength of the borrower. The Fed has signaled they will continue to steadily increase interest rates, which will constrain many buyer’s purchasing power.

As of now, both investment & user buyers are aggressively pursuing industrial properties, which is fueling our strong market. Once interest rates go up another notch or two in the next six to twelve months, we could see buyer sentiment change.

MARKET OVERVIEW

The San Diego industrial market tightened further in the first quarter with three-quarter of a million square feet of positive net absorption pushing vacancy and availability rates lower. The surge in construction over the past five years has not been able to keep up with the level of demand in the market. As a result, average asking lease rates continued their ascent, rising to another record high in Q1.

VACANCY & AVAILABILITY

Direct / sublease space (unoccupied) finished 1Q at 2.1%, a decrease of over half from the previous year’s vacancy rate of 4.2%. A large portion of this decrease can be attributed to the delivery of Amazon’s build-to-suit facility in Otay Mesa in 2021. This added 3.4 MSF of occupied space to the countywide total. The availability rate decreased at an equal measure and finished 1Q 2022 at 3%. Ten years ago, the vacancy rate for the county as a whole was 9%. Today the vacancy rate for every submarket cluster outside of South County is at 3% or less.

LEASE RATES

The average asking lease rate checked in at $1.17 per square foot per month, which is an increase of four cents per square foot over the previous quarter. Compared with 1Q last year, we see a 10.4% annual increase. By and large, negotiating leverage in the industrial market remains in the hands of the landlords, and rental rates remain elevated. Over the past decade, the average asking rental rate in San Diego has increased a total of 65%, and over the past five years the rental rates have increased at an average of 5.7% per year. In many cases, tenants with expiring leases have no alternative options in their submarket, placing the negotiating leverage squarely in the hands of landlords. In the most competitive areas, landlords are increasingly able to backfill new availabilities before the existing tenant vacates.

 
 

TRANSACTION ACTIVITY

The total space leased and sold in 1Q was approximately 2.9 MSF, a 24% decrease from the 3.9 MSF of transactions in 1Q 2021. There were 203 lease transactions recorded in 1Q bringing the average number of leases recorded per quarter over the last year down to 228. The preceding five years had a quarterly average of 292 lease transactions. The market is so tight there are many tenants deciding to stay in their current location rather than move to a new facility because of the lack of available options. All five of the largest leases in 1Q were in Otay Mesa buildings. This is a direct result of Otay Mesa leading the entire county in new construction the past couple of years. The largest space leased in the quarter was taken by Amazon who continues to show up in the largest transaction category quarter after quarter. The rise of e-commerce accelerated after the onset of COVID-19, and there has been an ongoing wave of large blocks of industrial space snatched up by Amazon in recent years. Sales volume was down in 1Q as well, but this is typical for this time of year. Four of the past six years saw the fewest building sales occur in the first quarter.


EMPLOYMENT

The unemployment rate in San Diego County was 4.0% in February 2022, down from a revised 4.7% in January 2022, and below the year-ago estimate of 7.9%. This compares with an unadjusted unemployment rate of 4.8% for California and 4.1% for the nation during the same period. Over the 12-month period between February 2021 and February 2022, San Diego County employment increased by 104,300 jobs, an increase of 7.5%. With the normal delay in reporting from the California EDD, employment figures from March were unavailable at the time of publishing this report. The total employment figures for San Diego County and the U.S. are now within 1% of their pre-pandemic levels. The U.S. added an average of 562,000 jobs per month in the first quarter of 2022.

Forecast: The brief, but drastic, recession we saw with COVID-19 was not able to slow the growth in industrial real estate. In fact, it had the opposite effect. Going into 2022 we find ourselves in a high inflation environment, entering a cycle of increasing interest rates. An increasing number of economic analysts are predicting an economic slowdown or even recession by next year. In the short term, demand in the industrial market continues to remain strong. Over the longer horizon, a slowdown of the broader economy could have a cooling effect on the industrial market.

CONSTRUCTION

4.7 MSF of new industrial projects were delivered in 2021, which was the fifth year out of the past six with more than a million square feet of new construction completed. Half a million square feet has been delivered in 1Q alone, with 1.9 million more currently under construction. This is in stark contrast to the 360,000 feet per year of new construction which was the annual average from 2008 through 2015. With very little land in the central county area available for development, most new construction in the county is happening around the edges. Over the past six years there have been more than one million square feet of new industrial development in each of South County, North County, and the I-15 Corridor, while Central County and East County combined have seen only a half a million total square feet of new development during that span.

ABSORPTION

There was 730,863 SF of positive net absorption in 1Q 2021. The San Diego market is on track for its twelfth consecutive year of growth to the total tenant footprint. The three largest absorption occurrences in 1Q were: M2 Ingredients moving into 155,000 SF in Vista, RL Jones moving into 154,000 SF in Otay Mesa, and USPS moving into 126,000 SF in Vista. Otay Mesa and North County each saw over 300,000 SF of positive absorption in 1Q. These areas have seen the majority of new construction over the past decade, and this growth of industrial inventory accommodates the growth of industrial tenants.

Inventory, Vacancy & Lease Rates, and Absorption

For more information, contact Alex Jize at AJize@voitco.com or (858)458-3361.

Alex Jize