Although San Diego felt the national economic slowdown during the first half of 2001, business is picking up in the city’s CBD.

"We’re like the proverbial butterfly coming out of its cocoon," said Peter Hall, president of Centre City Development Corp., the city’s downtown redevelopment agency. "We were the last to come out of the previous recession, so maybe we’ll be the last to go back in."

This year, nearly 3,000 residential units are under construction in San Diego — about a quarter of all the new units built in the county, Hall said.

But the most significant building is yet to come. The San Diego Padres ballpark project, started late last year, is not just a 46,000 capacity baseball-only stadium, but a plan to privately develop the 26 blocks surrounding the structure with hotel, retail, office and residential units.

The combined estimate of the project exceeds $1 billion, making it the largest redevelopment project in the history of the city, and perhaps even the nation.

John Kratzer, president and CEO for JMI Realty Inc., the development firm working with Padres owner John Moores, noted other ballparks erected in formerly blighted CBDs have resulted in new private development. But this project is different because JMI is responsible for satisfying the terms of an agreement between the city and the Padres to jointly finance the $450 million ballpark. "In other cities [notably Denver and Baltimore] this other private development happened naturally. What we did here is accelerate the clock a little bit," Kratzer said.

Construction on both the ballpark, slated for completion in early 2004, and a 512-room Westin Park Hotel started last year, were abandoned after the city decided to resolve litigation before it issued bonds to pay for its share of the ballpark. With a key court ruling in the city’s favor earlier this year, Kratzer said he expects the city to issue bonds and resume work shortly.

In addition to the ballpark and the $161 million Westin Park Hotel, the first phase for the ballpark district includes a $44 million "all suites" hotel of 203 rooms; East Village Square, a mixed-use residential and commercial complex that includes 200,000 sq. ft. of office and 100,000 sq. ft. of retail and restaurant space; Island Village, a 4-block, 1,000-unit residential neighborhood; and two 1,000 space parking garages.

Planned for a later start is 430,000 sq. ft. of office space in two towers inside the district. Plans for the structure include larger floor plates and higher ceilings favored by high technology companies.

The key factor of the master plan for an area now dominated by warehouses and vacant lots is creating a distinctively urban neighborhood, but one firmly rooted in its past, Kratzer said. "We have a chance to be a lot more like San Francisco than Los Angeles, which is what we’re aiming at: A true, 24 hour a day, work, live and play environment," he said.

Office vacancy hits double-digits

Looking at the San Diego County’s office market, fallout in the area’s telecommunications and other high tech companies resulted in large chunks of sublet office space, pushing vacancy rates in some areas to double digits.

For the first half of 2001, about 1.6 million sq. ft. became available, with 1.2 million of that in the first quarter alone, according to locally based Burnham Real Estate Services.

"A lot of this revolved around growing companies that took a lot more space than they really needed a few years ago," said Mike Philbin, Burnham’s managing director for transaction services. Hardest hit were the North City areas of Sorrento Mesa, where vacancy rates registered above 20%; University City at 7.3% and Del Mar Heights, where the vacancy rate 11.7% at mid-year.

Net absorption in the county for the first half of 2001 totaled 389,927 sq. ft., the lowest level of activity since mid-1992 when San Diego experienced negative absorption totaling 262,000 sq. ft.

David Marino, principal with Irving Hughes Group, a San Diego-based tenant representative, cited the example of Sun Microsystems, which had occupied two buildings in the University Towne Centre area, and has pulled out of both. "While many of the big companies are downsizing, lots of smaller venture-backed companies are struggling as well, with less funds and marginal prospects of getting ongoing funding for next year," he said.

Balancing that pessimism are plans for several Class-A office towers downtown, where the vacancy rate was 7.8%, or two points below the county average. Lankford & Associates plans to construct a 26-story, 460,000 sq. ft. office tower at the foot of Broadway and Kettner Boulevard. The firm is said to be close to obtaining its target, 50% pre-leasing.

The groundbreaking for the $150 million project is scheduled for May 2002, with completion slated for 2004, said Stacey Lankford, director of special projects. "There’s a huge demand for office space [downtown] right now that’s closely related to the recent residential boom. I think there’s a renaissance going on that’s bringing the city of San Diego in line with other big destination point cities," Lankford said.

Competing to become the first Class-A office tower built downtown in more than a decade is Catellus Urban Development’s One Santa Fe Place, a 26-story, 530,000 sq. ft. building. Catellusplans to construct a pair of towers to sit on either side of Broadway next to the Santa Fe Depot, the city’s historic and preserved railroad station. The first groundbreaking is set for 2002, but the start depends on obtaining preleasing agreements, Catellus said.

As part of Santa Fe Place project, Bosa Development of Canada is planning two 39-story, 222-unit condominium towers adjacent to the first Catellus office tower along Pacific Coast Highway. Catellus sold the two city blocks to Bosa during second-quarter 2001 for $26.2 million; the combined land and construction costs estimated for the condo towers is $255 million.

Burnham’s Philbin said despite a spike in the county’s office vacancy rate to 10%, things are still fairly stable and better than the last time the regional economy went into a tailspin. "While the vacancy rate is up 3 points since year-end 2000, the current rates are very respectable, and nothing like what we had in the last recession in the early 1990s when the vacancy rate was well above 20%," he said, adding that it was largely because the region was so badly hurt from plummeting real estate values, that lenders and developers were much more cautious in recent years.

Tom Wornham, senior vice president and regional manager for Wells Fargo Bank agrees. "Clearly, it’s a softer market but I don’t think we’re looking at the kind of meltdown that we had in the early 1990s," he said. In the commercial sector, rents have stabilized and in some areas have declined because of additional sublet space, but much of that space is being absorbed, Wornham said. According to Burnham Real Estate, about 2.9 million sq. ft. of office space is under construction countywide, yet about 55% of the new space is preleased.

Industrial growth concentrated in submarkets

On the industrial side, 1.1 million sq. ft. is under construction while 269,500 sq. ft. of R&D space is being built this year, Burnham said. Most new industrial and R&D building is occurring in either the North County area or South Bay, and in particular in the submarkets of Poway, Carlsbad and Otay Mesa, the latter along the U.S. Mexican border.

The Poway area’s 534,956 sq. ft. accounted for 56% of the county’s total year-to-date net industrial absorption. Available land in this market shrunk from about 800 acres to 160 acres, causing prices to rise on improved land from about $2.50 per sq. ft. in 1996 to $12 per sq. ft. this year, according to Burnham.

In contrast, Otay Mesa has about 4,000 acres available for future commercial development, with nearly 1,000 acres already improved. Prices range from $5.50 per sq. ft. to $8.25 per sq. ft., according to Linda Greenberg, senior vice president of Grubb & Ellis Co. The majority of the existing industrial land in Otay Mesa is used as warehouse, office and distribution space serving companies engaged in the ever-increasing U.S./ Mexican trade spurred by NAFTA. This year, three buildings in the Siempre Vive Business Park were completed on spec but about a third of the available space already is leased, Greenberg said. The vacancy rate for the area is 15%.

Multifamily stays hot

The continued population growth (San Diego is now at about 2.8 million, making it the third largest county in the state) combined with rising land costs and reduced construction of multifamily housing caused one of the hottest markets ever for apartments.

During the second quarter, 298 apartment sales in the county (involving nearly 4,500 units) made this the most active sales period since the third quarter of 1989, when 302 transactions involving almost the same number of units occurred, according to Burnham Real Estate Services. "There is a heck of lot of demand out there. I don’t think I’ve ever seen it like this," said Kent Williams, vice president at Marcus & Millichap in San Diego.

According to Williams, many owners who invested in apartments five to 10 years ago are ready to retire and are putting their properties up for sale. While most of the apartment sales were under 100 units, there were a few big sales, such as a 280-unit complex in Oceanside, purchased by River Oaks, LLC of Chicago for $26.2 million. The Arbors, with 214 units in Santee, sold for $22.7 million.

While rents continue to spiral, they still are relatively low when compared to some other areas of the nation, Williams said. But a dearth of multifamily construction has pushed the vacancy rate down to 1.2%, causing crowding in units that weren’t built to hold so many tenants. Average rents in the county at year-end 2000 hit $943, but most recently climbed 4.6% to $986, according to Marcus & Millichap.

The housing crunch has gotten worse in recent years because most of the construction activity has focused on single family homes, not on apartments or attached housing. While the area will see building of some 7,400 apartment units this year, 5,100 of those units are luxury units, according to Marcus & Millichap.

Hotels show resiliency

One of the region’s biggest industries, tourism, continued to show its resiliency in the face of the slowdown, based on the latest hotel occupancy numbers. For the first half of the year, hotel occupancy was up 0.5% from the prior year’s first half to an average 73.4% occupancy of all rooms, according to the San Diego Convention & Visitors Bureau. The average room rate was up 5% to $113.21.

San Diego stands to get a huge boost in visitor traffic with the September opening of the San Diego Convention Center expansion, which doubled the size of the existing building to 2.6 million sq. ft. The larger space allows the facility to handle major conventions, and accommodate more meetings. The $216 million expansion was financed by the city.

But attracting major conventions is still contingent on the building of sufficient hotel rooms. This year, local developer Manchester Resorts, the builder of the original 875-room Hyatt, began work on a 750-room expansion of the Hyatt Regency next to the Convention Center.

It took Manchester more than a year to line up a $230 million financing package that included refinancing the original hotel. That delay may have influenced the San Diego Unified Port District, the public landlord for bayfront property, to buy out an the development option it awarded Manchester several years ago for a 1,200-room hotel just south of the Convention Center. The district is now seeking another development partner for the project.

According to Wornham of Wells Fargo, the economic slowdown has been kinder to San Diego than other parts of the state, where the ‘tech wreck’ has been much more dramatic. "The way San Diego has weathered this slowdown is a bright spot," he said. "Investments [in real estate] are still being made. People are still buying."

Mike Allen is a San Diego-based writer.