Construction cranes are hardly an unusual sight in big cities, but in San Diego the sheer number of them dotting the horizon is startling. Developer John Kratzer counted 18 of the metal spires one day this fall. “These are the big cranes, the kind you use for high-rise construction,” says the president of JMI Realty, a local developer that also is responsible for several buildings in the area.
Indeed, an estimated $1 billion surge in new construction is under way in downtown San Diego. At the center of the activity is Petco Stadium, the new 46,000-seat venue for the San Diego Padres, which is scheduled to open in April 2004. The $449 million stadium is the cornerstone of a 26-block redevelopment area that includes two new high-rise hotels, with a third planned, and the first downtown office building of any size in more than a decade.
Construction activity is not limited to the ballpark, however. In the Marina district downtown, developers are building high-rise condominium and apartment complexes, including several new residential towers by Bosa Development of Vancouver, which imported its highrise-on-the-sea concept from Canada.
Meanwhile, in the Gaslamp historic district — San Diego's answer to the French Quarter — storefront buildings that once attracted tattoo parlors and saloons for sailors have become a gentrified tourist draw within a short walk of the city's convention center. In addition, construction continues on several buildings in the biotech cluster north of downtown centering on the University of California at San Diego.
The strength of the market has startled even long-term observers such as Bill Anderson, who recently stepped down as chairman of the city's planning commission. He says he is not taken aback by the scale of development under way in the city. Rather, he says, “I'm surprised by the rate.”
A Development Dynamo
The diversity of the San Diego economy, combined with steady activity in residential construction, primarily in the downtown area, has made the region a safe haven amid the slowly recovering national economy. Biotech, biomed and a defense industry revitalized by the war on terrorism are among the factors fueling the San Diego market, according to Lynn LaChapelle, a principal with Burnham Real Estate of San Diego. She cites a report from the San Diego Council of Governments, which projects an average 5.5% annual rate of economic growth for San Diego County through 2005.
In terms of office investment, the population growth, combined with the low rate of new construction and constraints on new development — including a dearth of open land and a time-consuming entitlement process — are creating a perception of scarcity in the office market, she adds. San Diego's population grew 12.6% to 2.8 million in the decade ending in 2000, according to U.S. Census figures.
The office market, however, has been scaling back for several years, with 750,000 sq. ft. under construction this year vs. 1.8 million sq. ft. in 2002. Still, “Washington, D.C. and Southern California are the strongest growth markets for development and investment,” LaChapelle says.
Even with those positive economic forces at plays, however, it may not be obvious what exactly is fueling the development dynamo in downtown San Diego. Unlike the urban cores of other major American cities — San Diego is the nation's seventh largest — downtown San Diego has never been a major corporate center. The office inventory is a modest 9.2 million sq. ft., compared with 30.1 million sq. ft. in downtown Los Angeles. “Even though we are larger than Seattle, San Diego is not the dominant city on this part of the West Coast because of our proximity to Los Angeles and Orange County,” Anderson explains.
A Cornerstone of Redevelopment
The most visible catalyst of the recent boom has been the ballpark, and the decade-long drum roll leading to its opening next spring. The stadium, in particular, is a financial juggernaut for Padres owner John Moores, who also is the chairman of JMI Realty. Moores' development company has received more than $300 million in public subsidies (including $225 million in municipal bonds to be repaid from hotel taxes, $171.8 million for land acquisition and infrastructure from the city and $21 million from the San Diego Unified Port District). The city and Moores own the ballpark together, with the city having a 70% stake in the project.
The agreement designates Moore as the master developer of the 35-acre “ballpark district” in downtown's East Village. The company owns about 10 acres in the area, and the rest is owned mostly by a patchwork of individual landlords. As of October, about $500 million in new projects by both JMI and others were headed for the ballpark district alone. Among the first of many high-rise projects planned around the stadium is a 32-story hotel-condo project. The hotel portion is known as the Omni Hotel, while the condo portion, called The Metropolitan, occupies the top 11 floors of the hotel.
Hotel Bookings Buoy Confidence
JMI also has an agreement with Kimpton Hotels and Restaurants to build a 235-room boutique hotel elsewhere in the ballpark district. Near the ballpark district is hotelier Doug Manchester's 34-story addition to his existing 40-story Hyatt San Diego, with a total of 1,625 rooms.
Another recent hotel deal, this one entirely separate from the ballpark, was the October sale of the historic Hotel del Coronado on Coronado Island just outside downtown San Diego. A partnership headed by CNL Properties, an Orlando, Fla.-based REIT, paid a reported $385 million for the 692-room hotel, which also is listed on the Register of Historic Places. KSL, a La Quinta, Calif.-based hotel operator, will own 25% of the 115-year-old hostelry.
Both the ballpark and convention-center bookings are buoying confidence in the local hospitality market. As of September, San Diego hotels reported an occupancy rate of 70.2%, compared with 61.1% nationally, according to PKF Consulting.
Office Investment Goes Deep
The ballpark district also will contain the first sizeable office project to rise in downtown San Diego in 13 years. In September, JMI signed a letter of intent with Cisterra Partners LLC to develop a building in East Village Square just outside the baseball diamond at Petco Stadium. The 300,000 sq. ft. building is scheduled to start construction next summer, with occupancy slated for late 2005.
Office vacancy overall was up to 13.8% in the third quarter, compared with 12.4% the previous year, reports Burnham Real Estate Services. Despite the uptick, Burnham predicts office absorption this year will increase 25% to 2 million sq. ft.
Like developers, investors also are active in San Diego. So far, nearly every major office building in downtown San Diego has traded hands this year.
Larger transactions countywide include Arden Realty's $69 million purchase of five buildings totaling 370,000 sq. ft. from Equity Office Properties Trust. In September, Glenborough Realty Trust of San Mateo, Calif., paid The Archon Group $75 million for the Aventine complex in University City.
Meanwhile, One America Plaza, a 570,000 sq. ft. downtown building owned by Shimizu America Corp., sold late last year for $166 million.
The biotech sector remains active in the North University City area. IDEC Pharmaceuticals is building a 350,000 sq. ft. headquarters, half of which will be devoted to laboratory-research space. In nearby Torrey Pines, the traditional center of biotech in San Diego, Pfizer took occupancy of the newly finished 142,841 sq. ft. building in Torrey Pines Science Center. Two additional Pfizer build-to-suits totalling 185,308 sq. ft. are still under construction.
Overall, however, the San Diego biotech market appears to be softening slightly. Of the 14.5 million sq. ft. of lab-related inventory, between 6% and 8% — or four times the vacancy that the market has ever reported before — sits empty, according to Doug Lozier, practice leader of the Life Sciences Group at CB Richard Ellis' San Diego office. One reason for the growing vacancy rate is the mergers-and-acquisition trend in biotech. Big pharmaceutical companies are acquiring promising start-ups. At the same time, venture capitalists' penchant for biotech has waned considerably in the wake of the “tech wreck.”
San Diego's overbuilt industrial market also is tightening, with annual absorption projected at 2.5 million sq. ft., compared with 2 million sq. ft. last year. The vacancy rate is “8% and dropping,” says Mickey Morera, a senior vice president at Burnham Real Estate. “We are reaching equilibrium.” Much of the vacancy, Morera adds, represents subleases and newly vacated owner-occupied buildings rather than new construction.
Grocery Centers Drive Competition
Far from being “over-stored,” the San Diego retail market continues to expand, according to Mike Clark, chairman of the retail division for San Diego's BRE Commercial/NAI. Demand is driving up the rental rates on well-located retail space to $36 per sq. ft. annually vs. the previous benchmark of $28 per sq. ft.
The hottest retail category is new grocery-anchored neighborhood centers, with nearly a dozen in various stages of development. “Competition to acquire grocery-anchored neighborhood centers is very tough,” says Clark. Cap rates on grocery-anchored neighborhood centers are “sub 7%, when you can find them,” he adds.
While no new regional malls are under construction, owners are enlarging existing centers. In San Marcos, World Premier Investments and Tone Yee Investments have lured Wal-Mart and Home Depot to the Vallecitos Town Center, a 300,000 sq. ft shopping center that could expand up to 500,000 sq. ft. The biggest project currently under way is the 800,000 sq. ft. expansion, including 500 residential units, of the 1 million sq. ft. Westfield Shoppingtown at University Towne Center. The development is jointly owned by Westfield and a unit of J.P. Morgan.
San Diego's transformation will continue over the next three to five years, says Sanford Goodkin, a San Diego-based real estate consultant. The city is already evolving, he says. “It is not the same city that it was in the early 1990s. Now it is an outstanding urban place.”
Morris Newman is a Southern California-based writer.
SAN DIEGO - BY THE NUMBERS
POPULATION: 2.8 million
UNEMPLOYMENT RATE: 4.1%
Source: San Diego Business Journal
METRO AREA STATS
11.5% vacancy, 3Q 2003
11.4% vacancy, 3Q 2002
Rent per sq. ft.: $25.94 3Q 2003
Source: CoStar Group Inc.
3.2% vacancy, 3Q 2003
2.0% vacancy, 3Q 2002
Rent per unit: $1,095 3Q 2003
Source: Torto Wheaton, Marcus & Millichap
2.6% vacancy, 3Q 2003
4.1% vacancy, 3Q 2002
Rent per sq. ft: $36 3Q 2003
Source: Reis Inc., BRE Commercial/NAI
8.1% vacancy, 3Q 2003
8.0% vacancy, 3Q 2002
Rent per sq. ft.: $10.70 3Q 2003
Source: Burnham Real Estate Services, CoStar Group Inc.
70.2% occupancy, First half 2003
70.8% occupancy, First half 2002
$112.99 Average Daily Room Rate, First half 2003
Source: PKF Consulting
MAJOR PROJECTS UNDER CONSTRUCTION:
Petco Park, a 46,000-seat venue for the San Diego Padres
Cost: $449 million
Owner: Padres owner John Moores and the City of San Diego
Completion: April 2004
Omni Hotel, a 32-story luxury hotel-condo project that will be connected to the new ballpark via a skybridge
Cost: $124 million
Developer: JMI Realty
Completion: Spring 2004
DiamondView Tower, a 300,000 sq. ft. building located outside Petco Stadium
Cost: $80 million
Owner: Cisterra Partners and JMI Realty
Completion: Late 2005
IDEC Pharmaceuticals Headquarters, a 350,000 sq. ft. building, half of which will be devoted to laboratory-research space
Owner: IDEC Pharmaceuticals
Completion: Summer 2004