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March 4, 2021
Oh, what a year it was.
Even though forecasting is, at best, a business fraught with failure, the year 2020 started with economic forecasts, including those of ULI, blindingly absent of any real sense of the economic calamity that would play out as a response to global pandemic. Most of those forecasts portrayed 2020 as a mirror image of 2019, with continued economic prosperity showing no real sign of impending recession, and all systems more or less “go.”
All systems were not “go” as the world, the U.S. and the San Diego region experienced a full year of economic deep freeze, pending vaccination as the likely solution to end the ravaging of the disease and reopen the economy. The nation has lost nearly ten million jobs in the past year. Over that time, the unemployment rate surged from 3.5% in January 2020 to 6.7% by the end of the year. The high point was 14.8% in April. In San Diego, there still is the sobering reality that the region lost an estimated 70,000 to 105,000 jobs last year, particularly in the lower wage and economically vulnerable sectors, and there is no letup in the region’s high cost of living.
The economic salvation of the San Diego region has always been the military, an employer which counts 150,000 persons who always meet their payroll. There are 354,000 military connected jobs accounting for 22 percent of all jobs in the region. But there is also an increasingly diversified mix of tourism, technology, life science, healthcare, manufacturing, and general business (most of which are small). Implication? A deficiency in one sector (tourism, for instance, this past year) does not take down the whole economy.
Because real estate is a reflection of the physical places which accommodate all of our activities, persons in the land use and real estate business have only to look to the pace of inoculation to offer some prediction on the pace of recovery of the real estate market.
To be sure, some aspects of real estate were more burdened than others. Those relative burdens are detailed in this Trends report and summarized here. But none of the real estate sectors have been left unscathed. There are both temporary and permanent changes in their use, occupancy and relevancy which will be reflected in their future performance. The more ”sticky” changes have been catalyzed by the pandemic. But they were going to happen anyway. What the pandemic wrought was a sooner-than-expected alteration in use and occupancy. That suggests some permanence.
COVID-19's Impact on Key Trends (2021 Emerging Trends in Real Estate)
| Accelerated by COVID-19 | Stopped or slowed by COVID-19 (for now) |
|---|---|
| Work from home | Appeal of CBDs/Density |
| Move to the Sun Belt states | In-person conferences and meetings |
| Suburban migration | Experiential retail |
| Public open space | Leisure travel/tourism |
| Retail sector transofmration | Business travel |
| Importance of redundant supply chains | Mass transit use |
| Proptech shift to WFH and building safety | Apartment amenity wars |
| Municipal/state fiscal issues | Tourist-oriented retail |
| Safety/health concerns in buildings | Live entertainment |
| Affordable housing crisis | University towns |
| Concerns about racial equity | Student housing |
| Federal deficit | Global supply chains |
| Bikes and scooters |
The challenge for land use professionals is to be able to sort out the sticky from the temporary and make decisions on development, redevelopment, investment, and adaptive reuse in a way which is not over reaction, while not ignoring the long-term consequences.
Other changes are not so sticky and are likely to shake off the aftereffects of pandemic as it slips further into our rear-view mirror. There are also silver linings for new types of real estate uses which are accelerating.
Photo By LOWE
Rendering of the reimagined Town and Country Resort. Photo courtesy of LOWE and the development team: Gensler (Architect), 1650 (Interior Design). Burton (Landscape Architecture) DavisREED (General Contractor).
San Diego’s economy of $241.2 billion gross regional product is forecasted to grow by 4.3% in 2021 and 5.5% in 2022, above its 10-year average of 2.7%. The challenge for the real estate and land use sectors is to provide the built environment to accommodate that growth.
To offer perspective, we conducted research comparing San Diego to other major metropolitan areas, confirming that our region is performing well, with obvious relative advantages, including our economic diversification, our coastal location which encourages a “blue” economy, and high quality of life, which portend a healthy economic future. But there are also disadvantages, the most obvious being our high cost of living. Our saving grace is that other California metropolitan markets (San Francisco-Bay area, Los Angeles, and Orange County) are more expensive and fraught with difficult regulatory frameworks, factors which encourage people and companies to look to us for expansion and relocation.
Photo By Urban Land Institute
This year will also be unprecedented in the introduction and continuation of big projects and investments, at a level seldom, if ever, envisioned in the San Diego Region. Among these projects include:
- Early phase development of the Port’s Chula Vista Bayfront; as well as continued planning for a new Seaport Village.
- San Diego State University’s Mission Valley West campus, which is well underway.
- Mega-projects in San Diego’s downtown in planning and/or construction including the completion of the conversion of Horton Plaza from dominantly retail to office; the buildout of the RAD project fronting San Diego Bay to create a giant commercial office and life-science footprint, as well as hotels and retail; the deal completion and entitlement of the San Diego Padres Tailgate Park project near Petco Park as a mixed-use, commercial office complex.
- The voter approved elimination of height restrictions in the Midway District and completion of negotiations on City-owned land to initiate the Sports Arena project by Brookfield Properties.
- Solidification of the proposed San Diego Regional Transportation Hub in a deal between the Navy and SANDAG on the old NAVWAR site, which one day could house thousands of housing units and commercial, sitting above multiple levels of transportation hub connected to the airport.
No doubt we neglected to mention a major project that is near and dear to someone including projects underway throughout San Diego’s North and South County. In its totality it is a lot to take in, particularly amid a recession.
What follows is a summary of the trends and prospects, by sector. It is a report card on how we are doing.
Photo By McNamara Development Ventures
Guild Townhomes at 30th St and Broadway
Residential
The residential market is multidimensional. It can be subdivided between rental and owner, single family vs. multifamily, geographically diverse and serving multiple and disparate market segments. Collectively, this has been the lone sector that has survived the year, and mostly prospered. The overarching reason is that the San Diego region is grossly undersupplied in its housing counts, a problem that has been, and is likely to remain, perpetual, but has never been worse.
SANDAG projected that during the 2012 to 2020 period we should have been adding 86,000 housing units. But only 49,800 units were added through Q3 2020, suggesting a shortfall of 36,000 units. Barely 6,700 units have been constructed over the past year as shown in the following chart:
Photo By London Moeder Associates
SANDAG forecasts that from 2020- 2030 the region will need nearly 160,000 housing units, or almost 16,000 total units per year. It’s a number that was regularly, annually achieved and surpassed in the last century, but that was a time of abundant land availability. It will be difficult to rise again to those levels with infill projects alone.
This housing count deficiency translates into both higher rent rates and sales prices. Rental rates mostly range between $1,500 and $3,500 per month, a range that challenges the affordability to much of our workforce. Construction costs are the main culprit that is contributing to an undersupply. Rental occupancies stayed high at 95%, but all was not equal, as many new additions (3,100 last year, 3,200/annum average over the past ten years) to the regional housing markets were apartments.
Rent rates actually declined about 2% in the region (likely related to COVID-19 related job loss), but with builders facing continued hard cost increases, this will result in either higher rents or lower construction counts. We predict continuing high occupancies throughout the sector. The spotlight will be on Mission Valley, as several large new apartment complexes now under construction will open at record rent levels not ever seen in that submarket, and which will test the ability of the market to absorb that stock. There is also likely to be continued development of apartments in San Diego’s suburbs, with special opportunities in converted retail centers, as well as along the urban transit corridors which are being incentivized by the City of San Diego’s recent planning and policy updates.
Photo By Colrich
The Harlow Mission Valley
On the for-sale front, all home types are selling well. For-sale housing production in the San Diego County region is at the lowest level since World War II. Median sales prices rose to $715,800, up 12.9% in the last 12 months, and double the level of the national average, but well below that of the remainder of metropolitan California. Other factors contributed to this price increase, including record low mortgage rates which decreased from 3.72% to 2.65% over the past year (Jan 2, 2020 to Jan 7, 2021); a dearth of resales, as the level of existing home inventory was 3,358 listings in December 2020 which, as of this writing, are averaging 29 days inventory of resale listings compared to 42 in 2020. This is a decline of 37% over the past 12 months. This was undoubtedly caused by persons adhering to the stay-at-home COVID-19 recommendations by deferring showing and moving, but also because there were comparatively fewer move choices, except out of state.
As of November 2020, new home closings in the region are averaging an annualized 3,507 homes, with a median new single-family home closing price of $878,500, up 27% in the past 12 months. The median new attached closing price is $596,000. New home sales volume is up 3% in 2020. But there are only 36 active new detached for-sale projects in the County, down 53% from last year and there are 40 active attached for-sale projects, a decline of 30% from last year.
Our forecast for 2021 is continuation of both price and rental rate increases, perhaps at a lower rate than in 2020. Our region has not reached a cycle ceiling, and is unlikely with a housing shortage, continued low interest rates, and lower overall pricing levels than elsewhere along the West Coast. While there are prominent new projects planned on old golf courses and converting sites, the lack of developable land and complex entitlement will ensure that if the economy remains steady demand will well outpace supply and continue to bid up pricing of housing of all types in all parts of the region.
Office Sector
Vacancy rates in the region’s 82 million square feet of offices grew over the year from 12% to 17% of newly leased and subleased space, reflecting the region’s mandate to relocate from office to home. But this statistic belies the sheer emptiness of most of the region’s office buildings. Over time they will reoccupy, the key question remaining whether that will translate into what will be the “stickier” level of decrease in office demand, at least from an employee per square foot perspective.
The word of the day in the office sector is “flexible” as the decades long evolution in the reduction of employee space requirements became an instant “revolution”, a consequence of the pandemic.
The trend was largely fostered by technology’s impact on all things work related from small computers, improved communication, and Internet access, all of which have accelerated the stay-at-home work trend. This has become a defining part of how many of us will permanently work.
So, why then is Downtown San Diego on the precipice of an office development spree not seen since the 1980’s, and certainly never at the 3 to 5 million new addition levels? Several projects are about to emerge to energize Downtown’s previously moribund office base of 12.1 million square feet, still the largest office node in the region, but one which has essentially not grown for over 20 years.
It seems that is about to change.
Photo By IQHQ Inc.
IQHQ Research and Development District (RaDD)
Under construction over the past year have been several small office structures, and the adaptive reuse of the Horton Plaza retail center into a 700,000 square foot office dominated project. Announced is the San Diego Padre’s venture to turn its leased Tailgate Park into a mixed-use project which might boast 1.35 million square foot of new office space and the recent acquisition of the 2.3 acre Salvation Army site in East Village by Kilroy Realty. But the transaction of the Harbor Drive Pacific Gateway complex, (now dubbed IQHQ’s Research and Development District) already with a completed new Navy Headquarters, to a targeted 1.7 million square foot Life Science complex, resonated with the promise that a new economic “cluster” is in the making.
The other important sectors of the office market include UTC, Carmel Valley, and certain other North County inland and coastal locations. These markets enjoyed healthy growth and quality tenancies such as Apple and other technology and life science firms, mostly a result of their proximity to UCSD, other “like” companies (creating an industry cluster), and high quality contemporary residential housing nearby.
Because the past year has persuasively demonstrated that much of our work can be conducted from anywhere, the level of demand will be tamped down.
The office sector will reoccupy throughout this year, as companies call for their soon to be inoculated employees to return to the office, at least for part of the week. We expect that this will translate into lower company office needs, which will result in a high level of subleasing activity as well as smaller per company demand for leased space as existing leases come to term.
At the end of 2020 asking rents across all classes was $3.42 per square foot per month, full service. There is likely to be a downward market correction in lease rates of at least 8%, as renewals are expected to account for 42% of total square feet in lease obligations set to expire over the next 18 months. We also expect significant interior design changes and the addition of outdoor space/amenities (where feasible) in office configurations as companies adjust to health concerns and strive for efficiency.
Our Forecast for 2021 is lower level of overall demand for office space and negative new absorption, suggesting higher vacancy rates. Economic growth in the technology and life science sectors will generate demand for new office space.
Photo By Regency
Rendering of Costa Verde Center renewal.
Retail
No sector has felt the sonic boom of change as much as retail, which currently employs more than 43,000 persons in the region, a decline of 13.5% over the past year, particularly in food and personal services. Here again, evolution has turned into revolution, as the long-term swing of purchases from bricks-and-mortar to online became a deluge during 2020. Online sales have grown by an average of 16.4% annually since 2010, outpacing average annual brick-and-mortar retail sales growth of 3.1% over the same period.
While neighborhood centers anchored by grocery stores have fared well, virtually every other retail center owner has been rethinking the future of their asset, as shopping center vacancy rose to 6.1% the end of 2020, and new leasing activity went down 16.1% year over year. Candidate alterations ranged from complete conversion to another use, to lower reduction of their retail footprint, to reactivation methods such as pop-up retailing, searching for new tenant categories and shaping formerly retail environments to entertainment and eating centers. Some of these conversions were well-underway before the current pandemic.
The future of retailing is omni-channel, including co-tenancy with other uses such as medical services, offices, entertainment/recreational, hotel and residential.
We caution not to be misled. Retail centers will take stock and ultimately prosper. Having experienced a year of stay-at-home boredom, we can anticipate a flight to congregation and entertainment, and retail centers will play no small part in that renaissance. Despite the ubiquity of online purchasing, there is still no substitute for the sensory enhancing experience of shopping. Practically speaking, it may be easy to buy electronics and other commodities online, but it is difficult to try on a pair of shoes or fashion strut online.
Leasing and retail sales should pick up in late 2021 and surge in 2022 due to pent up demand, but many large, big box operators will continue to struggle with the shifting retail landscape and there will likely be more national chain bankruptcies. COVID-19 also highlighted the stability of grocery-anchored centers, which will remain attractive. Discount and outlet retailers are likely to remain resistant to E-Commerce and should continue to expand their footprint, likely backfilling big box spaces vacated by other large chains. When the public health situation improves with the vaccine roll-out, food & beverage and fitness retailers are expected to bounce back quickly.
Photo By Stockdale
Rendering: The Campus at Horton Plaza
Our forecast for 2021: the retail sector has not yet bottomed out, and high vacancy rates which have been the result of COVID-19 inflicted business failures, will take time to reoccupy. Even then, we expect overall reduction in per store retail footprints. We also expect a significant reduction in asking lease rates. There will be new shopping centers, particularly in the neighborhood center category, but they will increasingly look more like retail dominant mixed-use projects.
Industrial
A beneficiary of cataclysmic change is the mis-dubbed “industrial” sector, roughly a 200 million square foot market in San Diego. The sector seemed to ignite with the pandemic, experiencing considerable new development and rent growth in highly technical manufacturing, warehouse, and distribution.
Yet, much of this sector is altering, an increasingly vestigial remainder of San Diego’s horizontal, tilt-up and manufacturing past. What once was called “industrial” has transformed into storage space at service to the retail sector, holding inventory to restock the smaller front-line stores, or receiving and distributing (from Amazon and others) directly to the consumers doorstep. Other industrial has robotized, employing far fewer persons, or have become high-tech hubs. San Diego long ago lost its luster as a manufacturing center, what with high housing costs, precious land, and geographic inconvenience.
Photo By San Diego Union-Tribune
Otay Mesa Port of Entry
Many formerly industrial submarkets, such as Kearney Mesa and Sorrento Valley have mostly converted to denser, more vertical commercial environments. The key exception is Otay Mesa along the Mexican border. As of Q4 2020, 5.6 million of the roughly 6 million square feet of industrial under construction is in Otay Mesa and are primarily distribution and logistics focused. Amazon will soon complete its giant (3 million square foot) distribution hub which will be the largest building ever constructed in San Diego.
The border location hugely contributed to this investment in a way that also has lately informed the development of other distribution hubs and related industrial along the border. The geographic advantage of San Diego’s adjacency to Mexico promotes “nearshoring” where distribution will grow in the post COVID-19 wake of international regulatory risk and port strikes which have massively disrupted supply chains. This growth in cross border distribution is the basis for the 5.6 million square feet of growth beyond the 17 million square foot base.
Our Forecast for 2021: the warehouse and distribution sectors will feed significant new growth in Otay Mesa and at various locations mostly in North County. Much will service the retail sector. Cold storage also represents a growth niche. Defense related manufacturing and aerospace will continue to thrive, as well.
It’s pretty simple: if we cannot travel, hold conferences or conventions then hotels do not get occupied.
Hotel
No sector failed so starkly in 2020 as did the hotel sector, which dropped from historic high occupancy of 90% one year ago, to 50% today, while rates declined from $180 to $130 per night.
This sector, which is perennially the riskiest in the real estate food chain (a characteristic of having to re-rent the space on a nightly basis) experienced the perfect storm in 2020.
The forecast assumes no group business at all through Q2 of 2021 since it is currently not permitted, 25% capacity constraints in Q3 and Q4 and a limited recovery of business travel through the end of the year. Leisure travel has been severely curtailed by stay-at-home orders over much of the past year. There has been competition from Short Term Rentals, which has not seen the decline levels of the much larger hotel sector, as many homes are better suited for isolation.
The Pendry Hotel San Diego
Our forecast for 2021: We are guardedly optimistic about the hotel sector for 2021. Once the vaccination count is way up (if not yet at herd immunity) we expect that great numbers of people will emerge out of hibernation and travel like nobody’s business. San Diego will be the obvious beneficiary of this. Consumer confidence will jump to new heights due to pent-up travel demand. 2021 will be much better as we approach summer. Even if we are wrong in our timing, recovery is inevitable when attractions fully open and meetings and conferences are allowed. It will take a few years for the hotel sector to restabilize and approach occupancy levels and room rates experienced a year ago. But there will be no new hotel rooms added to the inventory in the foreseeable future, a pause which will allow existing assets to resuscitate.
As in every recession, opportunity funds will emerge.
Capital Markets
So called “bottom fishing” is a defined art in the real estate investment world, and capital will be available. However, the level of underwriting scrutiny will be high throughout the year as developers must defend new projects in the throes of a recession and unprecedented change in real estate demand along all asset classes.
Photo By Urban Land Institute
2021 Emerging Trends in Real Estate Report
Investors in the built environment are unlikely to see any bargains in the apartment sector, which has remained strong and underdeveloped. Because so much has changed in the commercial environment across the investable sectors (hotel, retail and office) there is certain to be a high level of investor agnosticism except when the assets are well reduced in price, or if the program going forward is in line with the new demand metrics such as office efficiencies, contemporary retail, etc.
Supporting new development are the lowest interest rates in modern times, which favor the spectrum of debt lending from consumer takeout to construction loans. See more on how local ULI members view capital market opportunities in the third section of this report: Insights from District Council Members.
Photo By City of San Diego
Newly-elected Mayor Todd Gloria delivers the State of the City, virtually.
A Word on Land Use Policy, Population Growth, and the Regional Economy
2020 was a Presidential political year, creating a sea change in national leadership. But it was no less a sea change in local leadership, with Democrats achieving solid control in both the City and County of San Diego. The City of San Diego adopted an inclusionary housing ordinance, middle income density bonus program, and two elements of the Complete Communities policy initiative. We expect that there will be an aggressive push to redeveloping and densifying existing communities, all to add housing and to revitalize. The City’s Climate Action Plan also supports the efficiencies associated with urban development.
At the County level, things may get more difficult in an already onerous development climate involving San Diego’s vast unincorporated lands. Perhaps 2021 is the year that the newly installed Board of Supervisors revisit how and how much housing they should accommodate, not a small challenge given the delicate balance between environmental consciousness and economic sustainability.
This will paralyze the development of much needed housing for the middle class, young family market, whose heads of households are employed in San Diego, and who jam the I-15 corridor from their homes in faraway Riverside County in their carbon infested commute to their San Diego jobs.
The County has dedicated itself to reembark in its carbon offset program which, at the very least, will delay the over 10,000 housing units approved two years ago from starting construction. Who knows how much prospective new development a new Board of Supervisors will allow? But if last year’s failure of Newland’s large master plan in the form of a ballot measure is any indication, even the transportation rich unincorporated North County lands will remain green.
The State of California has been considering and gradually implementing new legislation aimed at encouraging more housing, infrastructure, and transit. There is tension between new and proposed State legislation and local policy, politics, and control.
There is also concern that these new policies may add to market interference, and the danger of making things worse, not better. But we do expect to see many new legislative proposals.
Of note is the second Port of Entry at Otay Mesa at the Mexican Border. This and other projects are meant to facilitate movement of people and goods, which heighten the interdependence of the San Diego/Tijuana greater metropolis by facilitating more efficient and greater movement along the various border crossings. It matters because Tijuana and the greater Baja region are experience a growth spurt of their own. We have included an overview of Tijuana real estate activity as a separate section in this report.
Photo By SANDAG
SANDAG Executive Director Hasan Ikhrata
The San Diego Association of Governments (SANDAG) is also considering its “Five Big Moves” program-—Complete Corridors, Transit Leap, Mobility Hubs, Flexible Fleets, and the Next OS– which is dedicated to creating policy and funding to integrate the transportation, infrastructure and housing needs of the San Diego Region over the next several decades. 2021 will be the year that the SANDAG Board may move forward with this plan.
A potential new challenge for our region is new growth. While the overall size of the 3.5 million San Diego region grew by a paltry 5,208 persons according to the 2020 U.S. Census, owed only to a natural increase of 15,633 persons, while a total net of 10,425 persons moved away. The San Diego region has historically grown by 20,000 to 40,000 persons each year. However, the rate of growth has slowed over the past four years. This is partially explained by recession, increasing home prices, dearth of new housing starts, and overall high cost of living.
However, something else may be at work. San Diego competes with other high-cost housing markets.
Local government has been more interested in investing public resources into tourism (such as current efforts to expand the Convention Center) and the military (“birds in the hand” so to speak) and not as aggressive as other regions in promoting the kinds of jobs and industry which generate the sustainable, high paying jobs, or in attracting a richer pool of investment capital. When we keep the firms, we reap the rewards, as with the life science cluster, which mostly incubate and stay.
Ultimately this could cause a slowdown in our regional economy. It is important that our political leadership throughout the region’s 18 municipalities, the County and the numerous special districts recognize the marriage between a strong economy and the need to accommodate new growth at a reasonable pace. They can cause change through investment which leads and supports land use mandates, including transportation, communication/connectivity, and capital improvements. Each of the projects detailed in this report were preceded and catalyzed by some form of public investment. Over time these investments paid off. While 2021 represents a fiscal challenge to all, we expect that our policy leaders will be aspirational, and plan accordingly.
ULI remains committed to assist policy makers in addressing the challenges ahead for the San Diego Region.
About the Author
Gary London is widely regarded as one of the nation’s foremost real estate advisors to many of the nation’s largest developers, investors, lenders and real estate asset managers and owners, Mr. London has been at the forefront in understanding and describing the many demographic, technological and societal changes which are transforming our cities and regions.
In practice as an analyst and strategic advisor for six decades, he has a reputation as a prescient, forward thinker who translates opportunities (or problems) into profits.
Mr. London is a Partner of London Moeder Advisors, a diversified real estate strategic advisory, development management, investment, capital access and analysis firm whose clients include investors, developers, lenders and public agencies. He is also considered to be one of the most experienced and effective expert witnesses in real estate litigation involving issues about valuation, damages, best practices and market analysis.
Learn more: www.londonmoeder.com