ECONOMY: Increase in vacant office space points to recession

Third quarter was worst yet for North County office market

By ZACH FOX - Staff Writer | Monday, October 13, 2008 8:18 PM PDT ∞

Vacant office space spiked during the third quarter in yet another indicator that North County has entered a recession.

The third-quarter numbers were the worst for commercial real estate since the residential housing boom went bust three years ago, according to a recent report by Grubb & Ellis, a commercial real estate firm.

Even as the housing market tanked, North County's commercial real estate market ---- composed of office, retail and industrial space ---- had maintained its value, with rents decreasing only slightly while house prices plummeted. But the sector suffered last quarter as consumer spending tumbled.

Commercial real estate joined a long list of negative economic indicators for San Diego County: job losses for five of the last six months, house prices 30 percent below a 2005 peak, foreclosure rates double a year ago and incomes failing to keep pace with inflation.

"Commercial construction and commercial real estate were holding up longer than the residential market, and that's one more thing that's no longer a positive for the economy," said James Hamilton, an economics professor at UC San Diego. "I would take any development there as an unfortunate move, but not an unexpected one."

Counting recently vacated space and newly leased offices, North County businesses abandoned 340,000 square feet of space during the third quarter. The previous low since housing started to falter in 2006 was a loss of 175,000 square feet of space in the fourth quarter last year, according to the Grubb & Ellis report.

The losses sent the overall office vacancy rate in North County to a new high of 19.2 percent.

Where the economy goes from here is largely dependent on consumer confidence and spending, said Edward Leamer, a professor with UCLA Anderson.

As analysts across the nation expect a weak Christmas season, significantly lower consumer spending could translate to even more business closures, higher office vacancies and a spike in job losses.

"All the anecdotes are extremely worrisome," Leamer said. "If that (consumer) fear continues, we're going to have a really bad couple of quarters. We need to have our leadership and the media say, 'It's not that bad, and it's OK to go out and spend.' "

So far, the looming San Diego County recession has not been as severe as the early 1990s from a jobs perspective, when the loss of aerospace companies translated into severe job losses.

Consumer spending, one of the economy's main drivers, could dictate the employment picture through the rest of the year ---- job losses in real estate and construction appear to have flattened from the same month a year ago, according to the August employment report released by the state's Employment Development Department.

Meanwhile, losses of retail jobs have started to slowly increase in small doses.

And spending might be tough, as incomes have not increased with the pace of inflation through 2007 for most North County cities, meaning consumers have spent more of their wages on necessities such as food and gasoline, according to U.S. Census data.

Grubb & Ellis did not release a third-quarter report for North County's retail sector, but there was no indication that it improved from the second quarter, when businesses abandoned 100,000 square feet of space, said Chad Iafrate, retail division broker for the company.

"The mom-and-pop guys are not doing deals, and they're feeling the impact of these slowdowns," Iafrate said. "Consumers have lost that false sense of wealth, getting paid $50,000 a year, and they were taking out an extra $15,000 every year from their homes. It was a spending frenzy."

Now that residential real estate prices have tumbled, consumers are unable to use their house equity as disposable cash. And they are struggling to keep up with their mortgage payments, as North County foreclosures have doubled from a year ago for the last several months, according to ForeclosureRadar, a Contra Costa County tracking firm.

On a broader scale, investors issued a vote of confidence in the national economy as the Dow Jones Industrial Average jumped 936 points Monday.

But that might not mean much for North County businesses, said Dan Seiver, a finance professor with San Diego State University.

"Consumers have been holding up as long as they can. If they can't borrow and their incomes aren't growing, they have to cut back," Seiver said. "The rest of the year is a washout, and we have to wait until next year for a recovery."

Contact staff writer Zach Fox at (760) 740-5412 or zfox@nctimes.com. Read his blog, "On the Realside," at nctimes.com/blogs/minding_your_business.