City of San Diego Is Set to Cash In on Bargain Rates for Office Leases

The City of San Diego is moving to take advantage of the current downtown office building glut by negotiating three massive leases that could cut municipal office space expenses by as much as $22 million during the next decade.

The lease package, which will go before the San Diego City Council for final approval on Nov. 4, is believed to be the largest single office-space package ever negotiated in San Diego County. While the city hasn’t released specific figures, the three leases now being negotiated are believed to include more than 300,000 square feet of space in three separate downtown buildings owned by three separate landlords.

The city’s ambitious plan to consolidate offices and cut lease payments is driven by a dramatic commercial real estate slump in Southern California that has forced building owners to counter high vacancy rates with low rents and significant tenant improvement allowances.

The city was well-positioned to take advantage of the current office glut because about half of its downtown leases are due to expire during 1992 and 1993.

The city is taking advantage of the same kinds of discounts that private-sector companies are getting in the current office glut. Competing aggressively for the relatively few office tenants shopping for leases, landlords are typically offering one year’s free rent on a five-year lease agreement, a concession that amounts to a 20% discount, local office space brokers say.

City offices now are scattered on different floors of the First Interstate Bank building and the former Union Bank building at 525 B. St. and two city-owned buildings. The city manager has recommended that offices be consolidated on contiguous floors in the Executive Complex near City Hall, the Security Pacific Plaza and the former Great American Bank building at 600 B St.

During past lease negotiations, the city generally was seeking relatively small square footage at times when vacancy rates were low.

But vacancy rates in San Diego County have soared to above 20%, far beyond the single-digit vacancy rates that building owners prefer, according to surveys conducted by commercial real estate brokers. And, TCW Realty Advisors, a Los Angeles-based consulting firm, believes that it will take about five years for San Diego’s glut to disappear.

So, while building owners and their lenders find the current economic climate to be distressing, “it’s a great time to be a tenant,” said Kraig Kristofferson, a San Diego-based leasing agent with CB Commercial Real Estate

“The timing couldn’t have been more perfect for the city with (half of) their leases expiring and the market as soft as it is now,” said Craig Irving, a vice president with Donovan/Irving Group Inc., the San Diego-based real estate consulting firm that is negotiating the city leases. “We believe the market is now at rock-bottom as far as the downtown high-rise segment . . . especially when you’re talking about large blocks of contiguous floors,” Irving said.

The favorable leases, which would take effect beginning in 1992, will allow the city to eventually pare its average cost per rentable square foot of downtown space to $1.32 per square foot, down from the current $1.74 per square feet. The leases eventually will save the city as much as $2 million per year, according to Councilman Ron Roberts, whose district includes much of downtown.

The city also has negotiated the right to lease up to 300,000 square feet of additional space in the three buildings, as well as the right to gradually abandon office space if the need for space decreases.

The city also anticipates that further cost savings following the consolidation of departments that now are spread out among different buildings. The city attorney’s office, for example, which is now split between the former Union Bank building and the city’s downtown office complex, would be consolidated on contiguous floors at one of the new buildings.

In addition to cutting municipal costs, the long-term leases also provide time to step back and review the oft-discussed, but now-dormant, proposal to build a new city hall complex.

The lease package “allows us (time) to make a decision on what is best for us long-term,” Roberts said. “While it (now) makes sense to be a renter, we do know that some day, the market is going to change, and that it won’t always make sense to be renting 300,000 square feet of space,” Roberts said.

“The important thing is that we’re not precluding any long-term options,” Roberts said. “If someone appears . . . and wants to sell us some land (to house a new city hall complex) at a terrific price . . . we’ll be able to move on it.”

The leases make economic sense even to San Diegans who believe that the city should commit to construction of a new government complex in downtown San Diego.

Wayne Raffesberger, executive director of San Diegans Inc., a group that represents downtown San Diego, applauded the city for negotiating leases that “might be the deal of the century” in San Diego. “There’s no way we could complain about leases (that average $1.32 per square foot,)” Raffesberger said.

But, as important as the cost savings, the leases give “breathing space . . . on the (important) issue of where does a new civic center go in downtown San Diego,” Raffesberger said. “In addition to the leases, the City Council (already has) created a task force that will examine our future (city complex) options.”

While city officials have tried to cut leasing expenses in the past, “this is the first time that the city has taken this (consolidated) approach,” Irving said. “In the past, they’ve (sought leases) on a pretty much piece-meal basis, as leases expired. But if you’re leasing 5,000 square feet at one shot, you’re not getting the same kinds of concessions that you’re going to get as a 100,000-square-foot tenant.”

San Diego isn’t alone in its bid to use the Southern California office glut to help cut costs.

The city of Los Angeles, which spends $14 million annually on leases for 933,660 square feet, recently acquired three buildings at what real estate analysts have described as rock-bottom prices. Los Angeles has acquired the three buildings to house its city transportation and personnel departments and the city clerk’s office.

While taxpayers will benefit from the proposed leases, the city’s successful bid to obtain rock-bottom leases is just one more indication of how soft the commercial real estate market has grown, according to observers.

“Some buildings may appear to be very successful but may have made some concessions that make them economically penalized for a period of time,” Kristofferson said. “That doesn’t mean it wasn’t a good decision. But in terms of the current value of the building, it may have reduced the value of the building if the (leasing) market turns around sooner.”

Additionally, “a lot of leases that were set to expire in 1993 and 1994 already been renewed . . . (because) many owners are realizing that they can’t play hardball with their existing tenants,” said Vince Botticelli, a senior marketing consultant with Grubb & Ellis Co. “In many cases, there are new concession packages involved . . . . Building owners have seen a lot of dramatic changes during the past two years.”

Future development also is likely to be impacted by the current office space glut. High vacancy rates, coupled with scarce financing, have scared most developers away from San Diego. In fact, only two major downtown office projects are set to begin construction over the next 18 months.

One of the two developers, Bentall Development Co. of Vancouver, Brithis Columbia, says its 421,000-square foot, 23-floor office tower project will start construction only after lease commitments are signed for 40% of the building. That’s more than the 15% to 30% pre-leasing required in past years.

Perry Dealy, Bentall’s senior development manager, admits the market is not likely to improve appreciably in coming months. In fact, leasing activity has slowed to a crawl: total space leased in the downtown are of San Diego is expected to total between 300,000 to 400,000 square feet in 1991, down from 600,000 square feet last year, Dealy said.

Times staff writer Chris Kraul contributed to this story.

The Buildings Where City Is Planning to Lease Space

Building: The Executive Complex

Location: 1010 2nd Ave.

Owner: Executive One Associates, an Illinois Limited Partnership

Lease Term: 10 years with the ability to terminate (penalty-free) at any time after seven years.

Rent: $1.35 per square feet per month over the life of 10-year lease.

Security Pacific Plaza

Location: 1200 3rd Ave.

Owner: Estate of Edwin S. Lowe in New York.

Lease Term: 10 years with the ability to terminate (penalty-free) at any time after seven years.

Rent: $1.35 per square feet per month over the life of 10-year lease.

B St. Building (Formerly the Great American Bank Building).

Location: 600 B St.

Owner: KOWA Real Estate California, a subsidiary of KOWA Real Estate Investment Co.

Lease Term: 10 years with the ability to terminate (penalty-free) at any time after seven years.

Rent: Beginning at $1.00 per rentable square foot per month, escalating to $1.55 over the term of the 10-year-lease.

(Each lease includes expansion rights, as well as an option to purchase. The city has not yet made public how much space will be taken in each building. Data supplied by the city of San Diego.)