San Diego, CA Industrial Market Report
Despite the challenging market conditions, San Diego shows promising signs of job growth and hiring activity. Leasing activity in San Diego has slowed down in recent quarters as economic concerns have made many larger space users more cautious. They are choosing smaller spaces or opting to renew their existing leases. Consequently, there has been an increase in vacancy rates, which contributed to the largest decrease in quarterly absorption in over five years. Construction activity is still strong, though nearly entirely concentrated in Otay Mesa. Additionally, rent growth has declined in the past year but currently remains higher than the historical average.
Q3 2023 by the Numbers
Source: CoStar Group
- Vacancy Rate: 4.7%
- Net Absorption in 2021: 7,000,000 SF
- Net Absorption in 2022: 1,900,000 SF
- Under Construction: 4,914,094 SF
- Average Monthly PSF: $1.83
Vacancy & Availability
The current vacancy rate of 4.7% has risen by 1.6% compared to 2022. Availability also rose to 8.7%, totaling 18.4 million square feet, the highest level seen in more than five years. Sublet space reached a record high of approximately 3.6 million square feet. The biotech sector experienced moderate demand, while logistics space near the border in Otay Mesa saw significant growth. Despite the rising availability and sublet space, brokers are concerned about the shrinking supply in the submarket, impacting rental rates and increasing vacancies.
Rent growth in the industrial market has experienced a gradual moderation, declining from its peak of 12.5% year-over-year in Q3 2022 to a more stable rate of 7.0% in Q2 2023. Notably, Otay Mesa stands out as the submarket with the lowest average rents in the region, offering attractive starting rates of approximately $1.83 per square foot in close proximity to the Otay Mesa Port of Entry. In response to market conditions, industrial tenants are now benefiting from allowances and concessions, while institutional owners are prioritizing occupancy rather than holding out for higher rents. Moreover, fixed annual rental increases are becoming more prevalent, with landlords increasingly implementing four percent escalations per year, surpassing the previous standard of three percent that had been in place for many years.
Over the last 12 months, the San Diego market experienced negative net absorption totaling 1.3 million square feet. Notably, the sublet market witnessed a significant surge in negative net absorption during early 2023, marking the largest decline in over five years. This was primarily driven by companies such as Panasonic and Dexcom adding available space to the market, with sublet space accounting for half of the negative absorption. The low leasing volume observed in 2022 contributed to a reduction in the overall tenant footprint at the beginning of 2023. Additionally, the sluggish start to industrial leasing in Q1 resulted in further instances of negative net absorption in subsequent quarters.
San Diego’s construction pipeline has reached its highest level in 10 years, with 4.9 million square feet under construction, with over 80% being available for lease. Otay Mesa in San Diego presents significant development opportunities and accounts for more than 80% of the construction completions since the start of 2020 and 50% of the industrial real estate currently under construction. The area benefits from its proximity to international railroad crossings and a busy land port of entry, with roughly 1.2 million square feet available within a one-mile radius. Infrastructure improvements and the presence of life sciences companies aim to improve connectivity and distribution in the submarket. Planned projects in Otay Mesa include the eight-building Otay Business Park, a 1.8 million square foot distribution center set to open by the end of 2024.
San Diego boasts a vibrant employment scene with an impressively low unemployment rate of 4.0% as of Q2 2023, significantly below California’s statewide rate. The city witnessed an increase of 6,900 jobs in June, fueled by the hiring surge in sectors like leisure and hospitality, which added 4,500 new hires. The professional, scientific, and technical services sector, along with finance and insurance, has shown substantial growth, with a notable increase of 700 positions compared to the previous month. San Diego’s thriving employment market, supported by over 350,000 jobs in the defense industry and a strong life sciences sector, continues to attract a portion of the population, including millennials, who make up 25% of the city’s residents.
San Diego Industrial Market by Building Size
- New construction in San Diego is heavily concentrated in the large-scale 50-100k+ SF size range. The majority of these projects have been developed in Otay Mesa, the last submarket with the available land to support large-scale development.
- Extreme scarcity of land, rising construction costs, and economies of scale have combined to make new construction of small-space industrial product infeasible for developers. This has insulated smaller buildings, typically owned by private investors, from the threat of new supply.
- Smaller buildings typically provide more flexibility for potential users, resulting in a more diverse and deeper pool of potential tenants. San Diego’s smaller scale product serves a wide range of manufacturing, distribution, warehousing, and flex uses.
- These factors have combined to create an imbalance of supply and demand resulting in historically low vacancy and availability rates, especially for smaller-scale product in San Diego. This in turn continues to drive market rent growth to new highs.