The recession has dealt San Diego a tough hand. Most of the cards, including the office market, multifamily, lower-end industrial and hospitality, are weak. America's eighth largest city, however, can count on a pair of aces: high-tech and biotech. Those industries are responsible for most of the monster leases signed in the past six months in this city of green hills and dramatic ocean bluffs.

Few other cities can currently report real estate transactions on this scale: A major pharmaceutical lease for 125,000 sq. ft.; one for a provider of online college courses for 250,000 sq. ft.; several biotech deals ranging between 60,000 and 80,000 sq. ft.; and a European investor paying $161 million for a downtown office tower. Is San Diego on the same planet as the rest of us?

The post-Lehman Bros. economy has hit this seaside city hard. Most categories of real estate, in fact, look as whiplashed as other U.S. markets. Housing prices in the third quarter of 2008 fell 23% from the same period a year earlier and multifamily prices dropped 48%, according to Cushman & Wakefield. Industrial construction sank by more than 50% over the same period.

Despite real estate blahs in San Diego, aerospace and pharmaceuticals continue to pump life into an otherwise comatose market. While the industrial sector reported 514,000 sq. ft. of negative absorption in the third quarter of 2008, the industrial sub-category of research and development (R&D), actually experienced 118,000 sq. ft. of positive absorption over the same period.

Strong military and defense-related businesses are staples of the market. Those sectors were the biggest employers in San Diego decades ago when the city was known as a Navy town and the downtown Gaslamp district was better known for tattoo parlors than high-end retail.

Even after several rounds of base closures in the 1980s and '90s, San Diego still retains Marine Corps Air Station Miramar and a half-dozen smaller naval installations. Defense contracting also has survived: San Diego gets $27 billion in annual Defense Department spending.

Not surprisingly, defense-related tenants have been among the biggest customers for R&D and office space in recent months. At the forefront has been Lockheed Martin's commitment to 157,884 sq. ft. at the Horizon Technology Center at Scripps Ranch, developed by Opus West.

High-tech communications companies, in particular, sent a strong message to San Diego landlords in the second half of 2008. In November, BAE Systems, a maker of radar and satellite equipment, leased 80,000 sq. ft. at Liberty Station in Point Loma. Liberty Station is a former military base redeveloped by Corky McMillin Cos. in a joint venture with the City of San Diego.

Another communications equipment maker, InnovaSystems, leased 45,000 sq. ft. of build-to-suit space in Mission City Corporate Center, managed by Los Angeles-based Maguire Properties. To the north, in the city of Carlsbad, Sierra Wireless America leased 63,477 sq. ft. at the Faraday Corporate Center.

Biotech's big appetite for space

The largest office leases last year, however, came from a client only tangentially involved in technology: Bridgepoint Education, a company that offers college courses on campus and online. Last February, Bridgepoint added 147,533 sq. ft. in an existing lease at Kilroy Sabre Springs, for a total of 300,000 sq. ft. The lease requires the landlord, Kilroy Realty, to add a third building to the complex.

If the deal in Sabre Springs elevated Bridgepoint to one of San Diego's biggest tenants of the past year, the education company rose even higher on the list by leasing another 250,000 sq. ft. in the Sunroad Centrum building, owned by a local outfit, Sunroad Enterprises.

After high-tech and aerospace, San Diego's biotech companies signed some of the biggest leases in the second half of 2008. From its origins 30 years ago in small start-ups along Torrey Pines Road launched by professors and students from the University of California at San Diego, the region now boasts 500 biotech companies that have spread across the northern suburbs of the city.

San Diego is now one of the country's leading biotech markets, on a par with the Boston-Cambridge area in Massachusetts or the Bay Area in Northern California.

As in other cities that contain growing clusters of pharmaceuticals and gene therapy-related businesses, a major research university serves as both anchor and talent pool for fledgling biotech companies. In this case, the University of California at San Diego is the intellectual mother ship. But there also are several private research institutions, including the Scripps Research Institute, Salk Institute and the Burnham Institute for Medical Research.

UC San Diego has entered into a joint venture with Burnham, Salk and Scripps, and plans to start construction early this year on a $115 million stem-cell research center. Part of their motivation for the project is to compete for $3 billion in research funds made available by the State of California. That kind of investment in medical research helps ensure that San Diego will continue to draw intellectual talent.

The biggest lease among biotech tenants in the past six months was Eli Lilly, the Indianapolis-based pharmaceutical giant, which leased 125,000 sq. ft. at Campus Pointe. The owner is Veralliance Properties, one of several national developers specializing in biotech properties. Another national biotech investor active in San Diego is BioMed Realty Trust, which is the landlord of a newly finished 83,966 sq. ft. building in University Town Center. The biggest tenant in that building is Illumina, a maker of genetic research equipment.

Northern San Diego also has attracted mainstream office building investors like Hines Interest, the landlord of La Jolla Commons in University Town Center. The national law firm of Paul Hastings Janofsky & Warner recently leased 55,523 sq. ft. in the building.

Despite these stellar deals, landlords may want to limit their expectations about biotech leasing, according to a local expert. The startup companies will likely be fewer in number due to a drying up of venture capital, according to Brian Ffrench a district manager in Julien J. Studley's San Diego office.

In suburban San Diego, at least one significant office sale took place recently — the $148 million purchase of 232,307 sq. ft. Paseo Del Mar building in Del Mar Heights by Metzler North America, a Seattle-based unit of a German investor.

Dutch buyer loves downtown

San Diego is a sprawling city with a suburban character. Downtown, with barely 11 million sq. ft. of office space, according to Cushman & Wakefield, is not the dominant market in a city with 70 million sq. ft. of space. A number of biotech firms have chosen more spacious settings in which to build their horizontal campuses with plentiful free parking.

Downtown, however, has grown in popularity with the explosion of condos and loft housing in recent years. The frustrating crawl of traffic on the county's major artery, Interstate 5, also has strengthened downtown's appeal for both tenants and investors.

In recent years, parking has been a thorn in the side of some commercial tenants, who left downtown for fancier space in the northern suburbs. The downtown office market has a central location that is convenient for “the talent pool, which is spread out all over the county,” says Matt Clark, a vice president in the San Diego office of Cushman & Wakefield.

Although office rent is cheaper downtown than in the costly suburbs — $35.28 per sq. ft. on a full-service, gross basis vs. $47.52 in Del Mar Heights — parking is expensive, with stalls priced at up to $200 monthly. One law firm that fled Del Mar Heights for downtown, Buchanan, Ingersoll & Rooney, is moving into 40,000 sq. ft. in the 707 Broadway building owned by Arden Realty.

However modest in size, downtown San Diego's office market has attracted its share of institutional and international investors. The biggest owner is The Irvine Co., which owns a half-dozen office properties in the market. The Newport Beach, Calif.-based developer and investor developed much of Orange County in the past four decades.

The biggest deal in recent months is the $161 million sale of the 306,750 sq. ft. DiamondView Tower to Wereldhave USA, the American unit of a publicly owned Dutch investor. In 2007, Wereldhave made its first San Diego purchase, buying the 655 West Broadway building for $210 million. The DiamondView is walking distance to the Gaslamp District.

Another major downtown landlord, the City of San Diego, is planning large-scale construction on a new Civic Center complex in the dilapidated central area, the location of current city government. In October, city officials selected Portland, Ore.-based developer Gerding Edlen to build a 1 million sq. ft., 41-story city hall, plus several surrounding buildings and parks.

Financial analysis shows that the city could save up to $400 million over 50 years by consolidating all its office requirements into the new complex. No construction dates have been set.

Recovery should occur in San Diego earlier than in other California cities, according to Ffrench, who offers a bold prediction: “San Diego will be the first major city in California to emerge from the recession.” The reason, he explains, is a diverse economy, in which high-tech and biotech play starring roles.

Morris Newman is a Los Angeles writer.

SAN DIEGO - BY THE NUMBERS

LARGEST PRIVATE EMPLOYERS

  1. Sharp Health Care
    13,872 employees

  2. Scripps Mercy Hospital System
    11,000 employees

  3. Kaiser Permanente
    7730 employees

Source: San Diego Transcript/Citizendium

CITY POPULATION
2.9 million

Source: U.S. Census Bureau

UNEMPLOYMENT RATE:
6.5%

Source: Bureau of Labor Statistics

METRO AREA VITAL SIGNS

Office:

13.9% vacancy, 3Q 2008

12.9% vacancy, 3Q 2007

$26.51 rent per sq. ft., 3Q 2008

$26.09 rent per sq. ft., 3Q 2007

Source: Reis

Multifamily:

3.5% vacancy, 3Q 2008

4.0% vacancy, 3Q 2007

$1,304 effective rent, 3Q 2008

$1,248 effective rent 3Q 2007

Source: Reis

Retail:

5.0% vacancy, 3Q 2008

3.5% vacancy, 3Q 2007

$22.60 rent per sq. ft., 3Q 2008

$22.45 rent per sq. ft., 3Q 2007

Source: Reis

Industrial:

7.3% vacancy, 3Q 2008

6.7% vacancy, 3Q 2007

$1.47 rent per sq. ft., 3Q 2008

$1.70 rent per sq. ft., 3Q 2007

Source: Cushman & Wakefield

Hotel:

57.9% occupancy, 3Q 2008

71.3% occupancy, 3Q 2007

$73.56 average daily rate, 3Q 2008

$94.97 average daily rate, 3Q 2007

Source: Smith Travel Research

MAJOR PROJECTS

Lane Field: A proposed 5.7-acre project at the former home of the Pacific Coast League Padres got a thumbs-up from the California Coastal Commission and the Unified Port of San Diego Commission in January. Developers plan to build a 525-room InterContinental Hotel, and a 275-room hotel operated by Woodfin Suite Hotels. The site will include 80,000 sq. ft. of shops and restaurants.

Developer: Lane Field San Diego Developers

Completion: 2012

Cost: $400 million

Hilton San Diego Bayfront Hotel: Convention travelers just got a new 30-story, 1,190 room hotel on 13 waterfront acres. The Hilton San Diego Bayfront Hotel boasts 3,000 sq. ft. of retail space, 165,000 sq. ft. of meeting space, a 7,300 sq. ft. fitness center and spa, and a saltwater pool. Guests also will find $2 million of commissioned public art at the hotel. The hotel was built on the former site of the Campbell Shipyard.

Developer: Portman Holdings

Completion: December 2008

Cost: $348 million