Market Report: San Diego Industrial - Third Quarter 2021
MARKET OVERVIEW
While the office and retail markets are still trying to find their way in the post-pandemic world, the industrial market is at decade-high levels of new development and transaction activity. Following the “Great Recession,” new industrial development in the county did not pick up again until 2016. There have been 10 MSF of new industrial real estate inventory added to the market since then, and yet the vacancy rate is now half a percentage point lower than it was at the end of 2015.
VACANCY & AVAILABILITY
Direct / sublease space (unoccupied) finished 3Q 2021 at 3.24%, a decrease of nearly a third from the previous year’s vacancy rate of 4.68%. As was called out in our previous reports, the 3Q completion of Amazon’s build-to-suit facility in Otay Mesa added 3.4 MSF of occupied space to the countywide total. This one project alone accounted for most of the dramatic drop in the vacancy rate this quarter. Effectively all of the county’s 2.2 MSF of industrial buildings currently under construction are in Otay Mesa. These new developments have less than half of their space preleased, which is the primary cause of the gap between vacancy and availability, which finished 3Q at 4.52%.
LEASE RATES
The average asking lease rate checked in at $1.09 per square foot per month, which is an increase of two cents per square foot over the previous quarter. Compared with 3Q last year, we see a 2.8% annual increase. By and large, negotiating leverage in the industrial market remains in the hands of the landlords, and rental rates remain elevated. An exception to this dynamic is for large requirements in Otay Mesa or on the Highway 78 Corridor where the balance of negotiating power is more favorable for tenants due to the recent wave of new development in those areas. From the start of 2014 through the end of 2018, asking rates increased 34.7% in total, at an average of 6.4% per year. Since the start of 2019, average asking rates increased a total of 5.8%. So rental rates continue to move higher, but the pace has slowed.
TRANSACTION ACTIVITY
The total space leased and sold in 3Q was approximately 3.3 MSF, a decrease from the 3.8 MSF of transactions in 3Q 2020. Amazon was notably absent from the top lease transactions of 3Q, as they have typically been a part of this over the past two years. Amazon is the biggest driver of the growth in the San Diego industrial market, but it’s not the whole story. The industrial sector beyond the headlines remains quite healthy. There were 190 lease transactions recorded in 3Q, which is a slow quarter compared with the quarterly average of 286 leases consummated in the prior three years. 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. These renewals don’t all show up in the transaction counts, which lowers the activity volume. The registered number of leases is down, but the total area being leased has increased. The market is on pace to finish the year above 10 MSF of leasing, the highest such total since 2012.
EMPLOYMENT
The unemployment rate in San Diego County was 6.6% in August 2021, down from a revised 6.9% in July 2021, and below the year-ago estimate of 10.8%. This compares with an unadjusted unemployment rate of 7.5% for California and 5.3% for the nation during the same period. Over the 12-month period between August 2020 and August 2021, San Diego County employment increased by 59,200 jobs, or 4.4%. With the normal delay in reporting from the California EDD, employment figures from September were unavailable at the time of publishing this report. At the end of September, the 4-week average of initial unemployment claims in the U.S. dropped to 336,000, the lowest figure since the start of the pandemic. The total employment for the U.S. is still 5.3 million jobs fewer than the pre-pandemic level.
Forecast: There is nothing on the visible horizon that suggests any disruption to the current strength in the industrial market fundamentals, barring an unforeseen shock to the entire U.S. economy. Moreover, COVID-19, which would qualify as a shock, did not upend the industrial market. For the San Diego market we will continue to see a bifurcation between the Central County where industrial property inventory is no longer being built at significant levels, and the outer submarkets which have the land for new construction and continued growth.
CONSTRUCTION
4.6 MSF of new industrial projects were delivered in the first three quarters of 2010, which is now the fifth year out of the past six with more than a million square feet of new construction completed. This is in stark contrast to the 360,000 per year of new construction which was the annual average from 2008 through 2015. With very little land available 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 1.5 MSF of new industrial development in South County, North County and the I-15 Corridor, while Central County and East County have seen less than half a million total square feet of new development during that span.
ABSORPTION
There was 4,013,149 SF of positive net absorption in 3Q, with 3,431,229 of that coming from the completion of Amazon’s new facility in Otay Mesa. This is the latest and largest sign of Amazon’s impact on the San Diego industrial market. The market has now seen 5,545,215 SF of tenant footprint growth through the first three quarters of 2021. This three-quarter tally exceeds the total net absorption from the past five years combined. Every submarket cluster in the county has posted positive net absorption for the year thus far, a demonstration that the strength of the local market is not limited to one category, or one area.
