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Can San Diego’s Priciest Submarket Get Even Pricier?

Rising Office, Retail Rents Anticipated in Recently Active Del Mar Heights
February 9, 2018
Kilroy Realty’s mixed-use One Paseo is currently under construction, with retail tenants expected to be up and running by early 2019. They will be followed by apartments and offices.
Credit: Kilroy Realty Corp.

A spate of recent deals and development activity have some local experts anticipating that rents could soon be heading higher in San Diego’s Del Mar Heights neighborhood - already among the priciest places in the nation to set up shop.

Brokers point to examples like Irvine Company’s entrance into the submarket with two recent office property acquisitions totaling nearly $200 million. There’s also Kilroy Realty Corp.’s signing of four upscale, full-service restaurants, along with popular burger chain Shake Shack, as the first tenants at its $650 million One Paseo mixed-use development, currently under construction in the heart of Del Mar Heights.

Add to these the continued wave of competitive renovations to older office properties - with multimillion-dollar makeovers being completed in the submarket by other big owners such as Equity Office Properties and Prudential Real Estate - and brokers are expecting the Del Mar Heights premium, relative to overall San Diego market pricing, to grow beyond its current 50 to 60 percent during 2018 and 2019.

A recent national report by JLL listed High Bluff Drive, where the bulk of the submarket’s offices are clustered, as the 13th most expensive office street in America. Researchers said the neighborhood as of late 2017 had an average yearly full-service asking rent of $54 per square foot ($4.50 per month), 67 percent above the San Diego metro average of $32.28 per square foot ($2.69 monthly).

An earlier report by Cushman & Wakefield pointed to Del Mar Heights Boulevard as the 14th most expensive retail location in the Western Hemisphere, with a 2017 annual rent of $105 per square foot, up from $78 in 2016. That San Diego street’s rent growth moved it up two notches in Cushman’s latest annual ranking covering North and South America.

Tony Russell, managing director in JLL’s San Diego office, told CoStar News that the recent Kilroy retail signings have implications for drawing in future office tenants at One Paseo and other Del Mar Heights properties. For one thing, they help give the neighborhood a hip and cool factor that it has long lacked, especially compared with other popular areas like downtown’s Little Italy.

As with other markets like University Town Center, prospective office tenants at Del Mar Heights will be looking at what’s nearby in terms of walk-friendly retail amenities, with an eye toward recruiting and retaining the best workers, including younger professionals. This will impact Kilroy’s future office and apartment leasing at One Paseo, where retail tenants will be the first arrivals in early 2019.

“They will have all of that in place, instead of relying on pretty renderings to bring in office tenants sometime down the line,” Russell said.

Brokers noted that Del Mar Heights and its surrounding Carmel Valley neighborhood have already broken the $5 per-square-foot, full-service monthly office rent threshold, with deals including the recent signing of virtual-reality technology firm Tsunami ARVR at the new two-building Torrey Point office complex. Property owner American Assets Trust Inc. and its broker, CBRE Group, are in talks with tenants to fill the remainder of the space at that campus.

Brett Ward, an executive managing director with Cushman & Wakefield who is handling office leasing at One Paseo, said that project is likely to command monthly rents similar to Torrey Point’s, around the mid-$5 per-square-foot range, and that level could be seen more frequently in the neighborhood as 2018 progresses. One sign is Irvine Company’s entry into Del Mar Heights, a submarket that in the past has seen office properties change hands infrequently compared with other neighborhoods.

Irvine Co., the San Diego region’s largest office owner, has said it is scouting more opportunities in Del Mar Heights and Carmel Valley, which is likely to spur interest from other investors. That could lead to continued escalation in office purchase prices as well as rents.

“Anyone making big office investments in that market at this point is probably expecting that rents are likely going to $5 or higher soon,” Ward told CoStar News.

Phil Lyons, a managing director with Cushman & Wakefield in San Diego, said Del Mar Heights’ annual retail rents have consistently bested the rest of the San Diego region during the past several years. That’s thanks in part to a 4.6 million-square-foot supply of Class A office space surrounding the neighborhood’s biggest retail center - Del Mar Highlands Town Center, owned and operated by Donahue Schriber - combined with an affluent nearby residential population boasting an average household annual income of $170,000.

“It’s very unique in the way that this area has the dense daytime population adjacent with the residential, and it’s really just one center that’s the dominant one,” Lyons said in Cushman's retail report.

Donahue Schriber has invested more than $70 million into retail expansions and parking improvements at the nearly 30-year-old Del Mar Highlands over the past six years, and the center now spans more than 300,000 square feet.

Directly across the street, Kilroy’s One Paseo will have a much smaller retail footprint, at 95,000 square feet, with most of the retail tenants expected to be up and running by spring or summer 2019. The retail portion of the 23-acre One Paseo will be followed by 608 apartments and 280,000 square feet of offices, set for completion by 2020.

Nelson Ackerly, senior vice president with Kilroy, told CoStar News that the developer is aiming to create a highly engaged center with numerous social gathering spots, with Kilroy curating a mix of retail that is also expected to include fashion boutiques, hair and nail salons, and possibly a fitness studio.

“The idea is to walk out of your office and have all of this at your front door - the restaurants, the stores, the gym,” Ackerly said, adding a big priority is having office and apartment dwellers access those elements without getting into a car. Traffic concerns were a big issue as Kilroy downsized its original plans in order to garner local residents’ support for One Paseo after a decade of planning.

Ackerly noted the full-service, upscale restaurants that Kilroy announced as the first tenants at One Paseo - Tocaya Organica, Sweetfin Poke, Ways & Means Oyster House and celebrity chef Michael Mina’s International Smoke - are all based on the West Coast and all are making their first or second appearances in the San Diego market. Subsequent to Kilroy’s announcement, the fast-growing, New York-based Shake Shack confirmed plans to open its fourth San Diego burger restaurant at One Paseo in 2019.

Carrie Bobb, a CBRE vice president who is handling retail leasing at One Paseo, said the development should provide a good complement to the nearby Del Mar Highlands center, while adding important new social spaces for residents and office workers. But for now, she’s reserving judgment on whether the project will raise the neighborhood’s retail rents.

“Rents now are pretty healthy on the retail side,” she said.

CoStar Group’s own research indicates that Del Mar Heights / Carmel Valley was among the few local submarkets where office rents surged past their pre-recession peaks as early as 2015. The trend was fueled by the neighborhood’s popularity with numerous tenants, including high-tech companies, biotech firms, law firms and financial services providers.

The area has long attracted company executives who purchased homes in nearby upscale residential neighborhoods, and workers seeking to minimize commutes from the region’s northern and southernmost residential enclaves.

One result is that office rents in Del Mar Heights / Carmel Valley grew 3.9 percent during the past year, even as the vacancy rate climbed to 14.8 percent, largely due to move-outs by a few large tenants to newer quarters elsewhere in San Diego. That included insurer ICW Group, which moved to Rancho Bernardo, and the Jones Day law firm, which went to UTC.

Because many of Del Mar Heights' office buildings are 20 to 30 years old, brokers are expecting more competitive renovations as owners add sought-after amenities such as collaborative workspaces, outdoor meeting areas and on-site eateries and fitness centers.

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Lou Hirsh, San Diego Market Reporter  CoStar Group   
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