San Diego Medical Office Overview: Q1 2014
By Chris Ross — Mr. Ross is vice president of healthcare solutions for Jones Lang LaSalle. He is a commercial real estate broker specializing exclusively in medical office and healthcare properties in San Diego County. He can be reached at (858) 410-6377 or at chris.ross@am.jll.com.
Market Conditions and Trends
Real estate activity among the county’s larger health systems remains steady. In particular, Scripps Health, Sharp Healthcare, and UC San Diego Health System have been relatively active in the leasing, acquisition, and/or construction of both acute care and outpatient facilities, especially over the past 24 months.
The county’s demand for healthcare real estate is coming not only from large medical groups and other traditional tenants, but also a growing pool of entrepreneurial and self-pay providers such as plastic surgeons, wellness centers, age management clinics, liposuction and other laser centers, and other cosmetic and cash-based practices whose prevalence is reemerging with the gradually improving economy. Most of these tenants prefer Class A buildings given their target clientele.
Vacancy and Rental Rates
Countywide vacancy at the end of Q1 2014 came in at 10.4%, virtually no change from that of Q4 2013 and down from the Q1 2013 rate of 11.3%, a positive sign for the market. With almost no construction in the pipeline for 2014, continued steady demand will result in a decline in vacancy throughout the rest of the year.
The average gross asking rent was at $2.47 per square foot at the end of Q1 2014, unchanged from Q4 2013 and slightly down from $2.53 per square foot a year ago. Most of this decline is attributed to Class B medical buildings, whose average rate dropped more significantly than Class A and C space. This is a result of nearly 70% of the county’s vacancy lying among Class B MOBs, primarily due to the recent flight to quality into newer Class A developments. Class A vacancy shows continued improvement, settling in at 7.5%, reflecting continued tenant demand for quality space and resulting in a 9.5% increase in Class A rental rates since 2011. Asking rents among Class C buildings also increased, up 4.8% over the same period, while asking rents for Class B buildings decreased 8.4%.
Absorption
In the first quarter of 2014, net absorption was slightly negative at 1,739 square feet — a classic example of how market statistics “on paper” can be misleading. A number of sizeable transactions stalled in Q1 and will likely be consummated in the second and third quarters. Once this takes place, the overall 2014 numbers will be representative of current demand levels.
Surveying San Diego Submarkets
Escondido / San Marcos: Leasing activity remains tapered in Escondido/San Marcos, not unlike the rest of the greater inland North County area, although there are signs that this could change throughout 2014. Nordahl Medical Centre, approximately three-quarters of a mile north of the new hospital, has reintroduced its ability to sell individual Class A medical condos. Owner-user opportunities are something all tenants should consider as a solution for long-term cost containment. The jury is still out as to how much movement this submarket is still expected to see, but we wouldn’t be surprised if more relocation and expansion plans are announced.
Oceanside / Vista: The Tri-City area is still making its gradual recovery, one small lease or sale at a time. Net absorption was essentially flat in 2013, and at $2.30 per square foot, the submarket’s average rental rate is $0.18 below the county average of $2.47. Premier Crossing and Vista Pointe Medical Plaza on Melrose Drive, and Creek View Medical Park on Via Centre Drive have reduced pricing enough to see better activity from providers looking for low-cost alternatives with relatively good value — somewhat of a trend that is taking place, particularly among private practices and in certain areas.
North County Coastal: Vacancy in coastal North County is extremely tight — by far the lowest in the county at 4.5% and a little more than half of its 8.0% peak from 2008. This continues to limit transaction volume since relocation alternatives are scarce. Though net absorption was essentially flat in Q1, it was +74,000 SF in 2013, which is highest in the county and about 50% more square footage than what the submarket has vacant today (51,000 square feet). Rental rates are now starting to climb, as evidenced by the county-high average rental rate of $3.30 per square foot (up from $3.24 in Q4 2013).
I-15 Corridor: By the end of 2014, we still expect the three most recently completed buildings — 4S Health Center in 4S Ranch, Pinnacle Medical Plaza in Scripps Ranch, and Pomerado Outpatient Pavilion in Poway — to be nearly all leased up (4S is full now). It is still generally a stable but quiet submarket, but Sharp Rees-Stealy, Palomar Health, and Arch Health all seem to be expanding so as not to lose any ground in this area, as it is one with steady growth and relatively strong demographics.
La Jolla / UTC / Sorrento: Leasing activity is strong in the greater UTC submarket. Scripps’ 383,000-square-foot Prebys Cardiovascular Institute celebrated the completion of its “skin” in September and is scheduled for completion in spring 2015. Scripps also commenced construction of its six-story, 80,000-square-foot MOB earlier this year. UCSD’s new Jacobs Medical Center had its topping out (when the last steel beam is placed) in October and will open in 2016. While UTC ranked second in net absorption in 2013, behind North County Coastal, it was only the opening of the new Sharp Rees-Stealy in Del Mar that was the difference. UTC also ranked second in average rental rate at $3.08 per square foot in Q1, a number that is expected to rise as vacancy tightens throughout the year.
Kearny Mesa / Mission Valley: Kearny was the only submarket in the county to experience negative net absorption in 2013, but it bounced back in Q1 2014 with +3,150 square feet of net absorption and a slight increase in average asking rate. A new 90,000-square-foot Class A development known as Mission West was recently announced. It will be located at 1904 Hotel Circle North and is scheduled to deliver early 2016. New vacancies are in the process of being announced at Rady’s 7910 Frost Street medical buildings. It will be interesting to see if they can achieve the lofty rents they are quoting (±$4.25 gross, plus parking charges) and how flexible they are as to whom they are willing to accommodate.
East County: Thanks to nearly 10,000 square feet of positive net absorption in the fourth quarter of 2013 and another 3,199 square feet in the first quarter, East County is now down to 9.6% vacancy. With MOBs, achieving single-digit vacancy is typically the benchmark for a healthy submarket, although we need to see steadier activity and a recovery in rental rates before we would describe East County as “healthy.” The leasing of midsize and large blocks of space is playing a large role in the overall strength of the county’s healthcare real estate market; but while East County is the largest submarket by total inventory, the average transaction size has been among the smallest.
Uptown / Hillcrest: The Hillcrest submarket was incredibly flat in 2013, but we finally saw a slight increase in rental rates in the first quarter. The boring news is yet another quarter of near-zero net absorption, this time coming in at a mere +84 square feet. Few tenants have any reason to move, and as dynamic a community as the Hillcrest population is as a whole, we have been seeing very little expansion or new practices. With two strong hospitals and more than one million square feet of medical office inventory, the submarket is poised for improvement. We are already seeing a lack of mid to large blocks of available space.
South County: Six projects in South County contain nearly 70% of the submarket’s vacancy. Since these six MOBs are geographically spread out, the leasing environment is less competitive among landlords than one would think. South County’s net absorption was flat in the first quarter, and it saw a slight uptick in average asking rent. In general, the submarket remains a quiet but stable one, while its population continues to grow.