2013

San Diego Commercial Real Estate Forecast
NATIONAL UNIVERSITY SYSTEM INSTITUTE FOR POLICY RESEARCH

A Publication From
Cassidy Turley San Diego www.cassidyturley.com/sandiego

San Diego State University The Corky McMillin Center for Real Estate www.sdsu.edu/realestate

NATIONAL UNIVERSITY SYSTEM INSTITUTE FOR POLICY RESEARCH

National University System Institute for Policy Research www.nusinstitute.org

A Letter From The CEO
Valued Clients and Colleagues: Throughout 2012, Cassidy Turley has continued to grow and expand across the United States in every discipline of our practice. In Southern California, we added teams in Downtown Los Angeles and Orange County, and we continued to grow in San Diego adding a healthcare investment team and multi-family investment sales brokers as well. We are now three years into the making of Cassidy Turley, and we are proud of the brand name and quality of what we have created from coast to coast. As always, we keep our clients’ needs first. We expand and enhance our cutting edge resources and services to consistently exceed our clients’ expectations. In 2013, we will provide you with innovative research products to bring you quality and insightful information as quickly as possible so that we can add critical value to your business decision-making process. Our commitment to developing these quality research products is unwavering, which is why Cassidy Turley San Diego is pleased to provide you with our 2013 Forecast highlighting the San Diego commercial real estate market. Locally, 2012 will go down as the year of stabilization. Technology, biotechnology, and even some traditional business service sectors such as tourism, banking, insurance and real estate, displayed growth. From November 2011 to November 2012 San Diego added a total of 24,600 jobs, an annual growth of 2.0%. Professional and business services recorded the greatest year-over gain, adding 8,600 jobs followed by eight other sectors. Overall, 2012 continued to be a year of modest corporate growth and stabilization, despite a volatile macro environment of slowing international growth, major national and local elections, the recent Fiscal Cliff decision, and the national debt ceiling. In San Diego, while leasing activity has been persistent through the year, the extremely large transactions have subsided, except for some notable transactions in the Life Science and Technology sectors. Still, no new speculative office or industrial development is slated to come online. However, there will be some build-to-suit developments delivered. We expect lease rates to continue to increase moderately in the core Class A markets. Given San Diego’s economy is heavily weighted towards defense, education, start-up technology and life science, it is imperative that our fiscal issues are prudently and quickly resolved to give companies and executives clarity around defense program spending, and tax treatment for the private investors. Leasing activity will be heavily influenced by decision-maker confidence levels and the health of our interwoven global and local economies. Our 2013 Forecast brings you local expertise on Office, Industrial, Retail, Investment and Multi-Family real estate in one comprehensive source. As we look ahead into 2013, we expect to see improvements and/or stabilization of market fundamentals in all sectors of the San Diego commercial real estate market. General highlights and trends for the 2013 market include: • Office: In 2013, the negotiating power between landlords and tenants in the Class A central core market is expected to shift. Although, tenants in the Class B and C categories and in secondary locations will continue to have attractive opportunities. Countywide, 2013 will be about strengthening leasing fundamentals with an adjustment to decreasing average tenant footprints. • Industrial: The industrial market has been improving in parallel with the national and local economies and is expected to stay on course while maintaining moderate yet steady improvements in 2013. The countywide direct vacancy rate is forecasted to decrease by 130 basis points to 7.5% by the end of 2013.

• Retail: Continued pressure on asking rents and competitive concessions offered by landlords will support positive leasing activity in 2013 resulting in a moderate decrease in the countywide total vacancy rate from 5.0% in 2012 to 4.8% in 2013. The recovery is underway, albeit sluggish. Retailers will continue to compete for the most visible locations, especially with a dearth of new construction projects on the horizon. • Investment: A slight increase in transaction volume is expected in 2013, hindered by economic uncertainty and political turmoil. Tax and spending changes may delay investment decisions as investors slowly become comfortable with their monetary effects on transactions. Demand for top products in secondary markets will remain strong, but will be met with a shortage of product. • Multi-Family: Development activity has heated up, making the multi-family sector the first to fully recover and begin sustainable expansion. Fueled by pent up demand and historically low interest financing, investment activity in this sector is forecasted to remain fierce. With household formation and employment poised for moderate improvement, San Diego should expect to see vacancies tighten and rental rates rise slightly by the end of 2013. Overall, we expect 2013 to be a positive year for San Diego’s commercial real estate market. Commercial real estate in this market will continue to be a relatively attractive place for investors to place their money in 2013. There will continue to be fewer and fewer distressed transactions in the market. There will remain creative opportunities for tenants/users that do not need to be in large Class A projects in the core markets. Given that no speculative office product will be delivered in 2013 it should bode well for landlords who have vacancy to fill in 2013. In any market, good or bad, there are opportunities. Our goal is to be a trusted advisor to you, our clients, to provide you with the most sophisticated insight and analysis you need to take advantage of these opportunities. We want you to achieve your real estate goals now and in the future. We are eager to continue working with you and to expand our relationship across all of our business lines and geographies. We live in a complex and dynamic economic environment, where uncertainty is ubiquitous. We are continually pushing ourselves and challenging each other to raise the quality of our product, service and insight for you. We welcome the opportunity to discuss the ever-changing landscape, as well as the specifics of our 2013 Forecast in further detail. For questions or additional information on San Diego market research, please contact myself or Jolanta Campion, Director of Research, directly at 858.625.5235 or Jolanta.Campion@cassidyturley.com.

Sincerely,

Daniel T. Broderick Cassidy Turley San Diego President & CEO

Contributors
NATIONAL UNIVERSITY SYSTEM INSTITUTE FOR POLICY RESEARCH

Cassidy Turley San Diego Jolanta Campion Director of Research T 858.625.5235 F 858.630.6320 jolanta.campion@cassidyturley.com Anthony Espinoza Research Analyst T 858.625.5267 F 858.630.6320 anthony.espinoza@cassidyturley.com Shannan Diver Research Analyst T 858.625.5252 F 858.630.6320 shannan.diver@cassidyturley.com Contributors: Ben Schwartz, Transitional Reseacher Sean Workman, Manager, Creative Services Lesley-Joann Kolb, Marketing Manager 4350 La Jolla Village Drive, Suite 500 San Diego, CA 92122 www.cassidyturley.com/sandiego

National University System Institute for Policy Research Kelly Cunningham National University System Institute for Policy Research Economist and Senior Fellow T 858.642.8008 kcunningham@nusystem.org 11355 N. Torrey Pines Road La Jolla, CA 92037 www.nusinstitute.org

San Diego State University Michael Lea, Ph.D. Director, The Corky McMillin Center for Real Estate College of Business Administration T 619.594.8327 F 619.594.3272 mlea@mail.sdsu.edu Xudong An, Ph.D. Associate Professor Department of Finance College of Business Administration T 619.594.3027 F 619.594.3272 xan@mail.sdsu.edu 5500 Campanile Drive San Diego CA 92182-8238 www.sdsu.edu/realestate

Table of Contents
San Diego Economic Overview . 1 San Diego Office . . . . . . . . 9 San Diego Industrial . . . . . . 21 San Diego Retail . . . . . . . . 31 San Diego Investment . . . . . 45 San Diego Multi-Family . . . . 55

San Diego Economic Overview
Fig. 1

San Diego Gross Domestic Product (GDP)
Fig. 1

San Diego’s Economic Momentum Slowing in 2013
San Diego’s economy continues to modestly grow despite multiple “bumps” along the way. Job creation remains largely subdued as the economy struggles to mend. 2012 began with hopes of accelerating momentum and greater employment rebound. Indeed, job numbers jumped in the middle of the year, but dwindled as the year progressed. The uncertainties of fiscal, monetary, and regulatory policies in an election year, with Congress remaining in gridlock and fiscal cliff looming, all served to diminish prospects of more vigorous economic expansion. Sluggish Outlook for Economic Growth 1

San Diego Gross Domestic Product (GDP)
San Diego GDP Percentage of: (Billions) CA U.S. $114.372 8.54% 1.11% $123.180 8.88% 1.16% $130.944 8.96% 1.18% $141.549 9.02% 1.19% $151.571 8.97% 1.20% $159.813 8.89% 1.19% $166.387 8.89% 1.19% $171.174 9.01% 1.20% $168.976 9.24% 1.21% $171.568 9.14% 1.18% $178.866 9.13% 1.19% $185.759 9.14% 1.19% $193.585 9.15% 1.19% Annual Change Constant Dollars* S.D. CA U.S. 1.3% 0.1% 1.1% 5.3% 1.9% 1.8% 3.9% 3.1% 2.5% 5.2% 4.6% 3.5% 3.9% 4.2% 3.1% 2.2% 3.3% 2.7% 1.3% 1.0% 1.9% 1.0% -0.4% -0.3% -2.9% -4.7% -3.1% 0.9% 1.7% 2.4% 2.1% 2.0% 1.8% 1.7% 1.8% 1.7% 1.5% 1.6% 2.0%

Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012e 2013f

*Adjusted by GDP implicit price deflator. e: estimate f: forecast Source: Bureau of Economic Analysis, U.S. Department of Commerce; National University System Institute for Policy Research. *Adjusted by GDP implicit price deflator. e: estimate f: forecast

System Institute for Policy Research. (GDP), the most comprehensive strongest since 2006. Momentum,

Source: Bureau of Economic Analysis, U.S. Department of Commerce; National University

measure of the economy, reached an estimated $185.8 billion in 2012. San Diego slightly led the rest of California’s economic expansion with northern California bolstered by thriving international technology companies, such as Apple, Facebook and Google. San Diego’s GDP is estimated to

while still positive, slowed in 2012 and is projected to further slow in 2013. San Diego slightly exceeded California’s 2.0% gain in 2011, and bettered the U.S.’s 1.8%. Growth in 2012 faded across the nation as San Diego matched the 1.7% U.S. gain, and slightly trailed California’s 1.8% gain (Figure 1).

San Diego’s gross domestic product

have grown 2.1% in 2011, the
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The outlook for San Diego in 2013

is to further slow to 1.5%, lagging California’s similarly tepid expansion at 1.6%. The forecast of 2.0% growth for the U.S. will be the second highest rate of expansion in six years, only exceeded in 2010 as the country emerged from recession in 2009 (Figure 2). Trends Among San Diego Industries Among San Diego’s many core assets is a diversified economy. A metroplex of telecommunications, biotech, computers, and electronics, mixed among popular travel destination and an international border, with extensive military base operations and associations. San Diego continues to benefit from near perfect climate attracting an educated and talented labor force, technically advanced research institutions and educational systems, retaining both active and retired U.S. Navy and Marine Corps personnel, and generally thriving retirees. These attributes

usually bestow San Diego with an above average healthy and thriving economy. San Diego’s technology industries significantly bolster the region’s vitality and economic prosperity. While tech companies account for only 6% of San Diego businesses, the industries account for 11% of all
Fig. 2

jobs, and 21% of all payroll wages. The average annual wage among San Diego tech companies is $101,500 as of 2012, 90% higher than San Diego’s overall average wage of $53,500. Separating non-technology jobs from the overall average, the wages of non-tech industries is $47,500, less than one-half of technology company wages.

Comparison of Annual Change in GDP

Source: U.S. Department of Commerce, Bureau of Economic Analysis. e: estimate, f: forecast by National University System Institute for Policy Research. Cassidy Turley San Diego | www.CassidyTurley.com/SanDiego

2

San Diego Economic Overview
Fig. 3

Percent of San Diego Jobs/Total Earnings
Percent of San Diego Jobs/Total Earnings
23.1% 25.3%

Fig. 3

risen significantly relative to the total economy. Healthcare has continually led gains growing even throughout the recession. Home to a significant and expanding population

40.4%

44.8%

31.1%

28.2%

High Wages 30.7%
26.6% Medium Wages Low Wages

of retirees, San Diego requires ever more health care services with local health providers significantly expanding facilities and services. Government, including active duty military, directly contributes about 18% of San Diego’s GDP. Contributions from government expenditures rose significantly over the past decade almost entirely due to expansion in military spending. Potential federal government decisions to severely cut defense expenditures have major implications for San Diego, home to the largest number of military personnel anywhere in the country. In total economic impact, nearly one-quarter of the regional economy depends upon Department of Defense (DoD) expenditures. Despite these concerns, San Diego could potentially benefit if cutbacks are enacted elsewhere and reassigned or consolidated to local bases. A strategic refocusing on Pacific Rim activities could also

45.8%

46.5% 28.9% 28.6% 2011 Earnings

2007 Jobs

2011

2007

Data on occupations and average

Source: “Quarterly Census of Employment and Wage”, 1Q12. U.S Bureau of Labor Statistics.

Source: “Quarterly Census of Employment and Wage”, 1Q12. U.S Bureau of Labor Statistics.

average wage), slightly increased in proportion, and barely decreased in total compensation. As depicted in figure 3, the proportion of workers employed in high wage occupations in San Diego increased between 2007 and 2011, as well as the proportion of wages earned by those workers. In contrast, the number of San Diegans working in middle wage occupations declined, while low income jobs slightly increased in proportion as well. Professional and business services and the health care industry have
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compensation shows the number of higher wage occupations (defined as 25% higher than the countywide average wage) increased between 2007 and 2011. In addition, compensation for those positions that require specific training and greater technical skills increased by a stronger pace than other occupations. At the same time, middle income jobs (+/- 25% average wage) were most squeezed over the past four years in terms of both number 3 of jobs and total compensation. Low income jobs (25% below

bolster San Diego’s extensive Navy operations. Defense contractors locally are deeply integrated in developing and producing modern military systems and applications increasingly used for more efficient operations especially with overall budgets being cut. Cutting-edge applications developed among San Diego contractors include intelligence gathering, cyber security, and other defense-based
Fig. 4

electronics and software systems. Despite manufacturing employment decreasing in number, production dollars in recent years have steadily risen as value-added manufacturing processes expand. Increasing high value manufacturing processes use fewer but more high skilled (and higher compensated) technology workers to produce far greater output. San Diego is

a hub for high-value research and innovation in biotechnology, genomics, communications, software development, cybersecurity and clean-tech. San Diego’s historic aerospace sector is also thriving particularly as unmanned aerial vehicle (UAV) systems are prominently used by the U.S. military. Travel and tourism is staging one of the more dynamic recoveries

San Diego Population Change

Source: California Department of Finance; estimate and forecast by National University System Institute for Policy Research.

4

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San Diego Economic Overview
Fig. 5

Comparison of Change in Nonfarm Jobs

Real estate activities account for nearly one in every five dollars generated by the regional economy. Housing construction is improving, although admittedly from greatly reduced levels the past several years. Demand for apartments and other rental housing has significantly risen. Two-thirds of new residential construction is multiple-housing units. Home prices appear to have bottomed and slightly risen throughout 2012. Further price increases are likely to be mixed, however, as the weak economy persists, employment opportunities are constrained, and foreclosures continue to work through the system. This trend will continue in 2013 with relatively small gains in number of units added to the housing supply. Non-residential real estate is similarly mending but a long way from full or healthy recovery. Office and industrial vacancies remain relatively high, but appear to be stabilizing among some key submarkets. Rents remain relatively flat in most markets, while others

Source: U.S. Department of Labor, Bureau of Labor Statistics; California Employment Development Department.

of San Diego economic sectors. Both hotel occupancies and room rates are rising as visitor numbers rebound and attractions and event attendance increases. Population changes within San Diego County reflect diverging patterns. San Diego’s population growth over the past decade slowed from previous eras, which at times was two to three times higher than current numbers despite a much larger population base now (Figure 4). Migration the past several years 5 shows almost as many residents moved away as international

migrants moved to San Diego. Only because of natural increase from births has San Diego added population recently by some 26,00027,000 per year. The result is an increasingly ethnic and culturally diverse mixture of younger age groups, while the average age for white residents continues to grow older. With lowered levels of population growth resulting almost entirely from babies, demands on additional housing are somewhat muted, at least for now. Consumer sales, business demands, and tax revenue increases are also moderated by this type of population increase.
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still decline. Premium properties in key areas continue to attract the best demand with discounted rental rates. With slow but steady job increases, demand for local space is rising among office, industrial, and other commercial properties. Slowly Improving Employment Outlook Overall, employment trends show generally improving prospects in San Diego, particularly as sectors that had lost the most jobs have started adding jobs again. For the first time since the recession began, employment in construction, retail,
Fig. 6

and accommodations increased jobs in 2012 (Figure 5). While economic production is improving, employment in San Diego, as in the rest of the nation, remains far below pre-recession peaks. Between 2007 and 2010 San Diego lost 103,300 jobs. Since that time, approximately 51,000 jobs have been added through 2012, just about half-way toward total recovery in job numbers. While San Diego exceeded relative gains in state and national jobs prior to the recession, in recovery San Diego has more or less equaled the

nation’s job creation. California is yet to reach 2002 levels. Nearly every major industry category in San Diego added jobs during 2012, with the notable exceptions of manufacturing and wholesale trade. Shipbuilding and aerospace added some jobs, but significant losses recorded among computer and electronics employers dragged manufacturing job numbers down. Employment in wholesale trade also fell despite the local retail sector adding jobs. The strongest job growth continues to be in health care, administrative and support services, professional and technical services, as well as retail, restaurants, and hotels. After five consecutive years of job losses, with 40% of the jobs existing in 2006 being lost, construction started adding jobs again in 2012. Further increases are anticipated in 2013 with stirrings in both residential and commercial construction reviving. Prior to the recession, San Diego’s unemployment rate was generally lower than the rest of California and the U.S. unemployment rate started 6

Unemployment Rate in Comparison

Source: e: estimate f: forecast. California Employment Development Department; Forecast by National University System Institute for Policy Research. Cassidy Turley San Diego | www.CassidyTurley.com/SanDiego

rising in California and San Diego

San Diego Economic Overview
well before the rest of the nation. San Diego’s unemployment rate continued rising above the national rate, although not as much as California’s double-digit increase. As unemployment slowly comes back down, San Diego maintains more or less the same marginal position between U.S. and California rates (Figure 6). San Diego’s unemployment rate as of 2012 averages 9.0%. The rate should continue gradually improving to 8.5% over 2013, approaching but still not reaching expected U.S. levels, while remaining well below the rest of California. Improving Sales Activity Reflects Rising Consumer Prosperity 7 Consumer spending in San Diego as measured by taxable sales is rising
Fig. 7

Annual Percent Change In Taxable Sales
Southern California Counties

Source: California State Board of Equalization. p: preliminary, e: estimate, f: forecast by National University System Institute for Policy Research.

but still not regaining pre-recession levels. While rebounding from 200809 lows, adjusted for inflation sales remain lower than every previous year back to 1999 (Figure 7). One in seven San Diego business
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outlets closed during the course of the recession. Since 2010, 4,500 outlets have been reopened or added, but still remain 8% lower than the number existing in 2006.

In 2010, San Diego led the rebound in taxable sales among southern California counties. Riverside, San Bernardino, and Orange County plunged deeper in 2009, and subsequently rebounded above San Diego’s 2011 percentage increase. San Diego’s sales increased at a faster pace in 2012, and are projected to tie with Orange County’s increase in 2013, while exceeding the rest of California. Many factors influence spending — consumer confidence level, availability of credit, inflation, and most importantly, employment. With the labor market gradually improving, spending is also increasing although gains are projected to slow. Continuing levels of high consumer debt will restrain greater spending.

Rising inflation is also limiting spending gains, particularly as gas and energy prices soar. San Diego’s cost of living accelerated from only 1.3% in 2010 to 3.0% in 2011, and 2.1% estimated in 2012. San Diego’s inflation rate is forecasted to rise in 2013 to 2.4%. Guarded Outlook for 2013 Falling into recession for at least part of the year in 2013 is possible. The sluggish recovery could lapse with any number of shocks, from state and federal policy actions, such as the fiscal cliff and tax and regulatory increases. The slow growing economy reflects a lack of consumer confidence and continued business uncertainty stifles willingness to take on workers and greater expansion. In spite of these heightened
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cautions, the outlook for San Diego is continued albeit modest improvement in economic activity continuing through 2013.
By Kelly Cunningham, Economist, Senior Fellow, National University System Institute for Policy Research www.nusinstitute.org.

8

San Diego Office Forecast

9
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San Diego Office Forecast
Negotiating Power Will Shift in Central County
The San Diego office market is a tale of three counties – North, Central and South. Evaluating the performance of submarkets located in North and South Counties, the recovery does not feel as strong and optimistic as in submarkets located in the Central County. The annual leasing as measured by net absorption in Central County is far above the pre-recession levels recorded in 2006 and 2007; and is the same as during pre-recession years in North County and well below the pre-recession levels in South County.1 As a result, the countywide office market performance seems good but not great. In 2013, the current trend - Central County leading the recovery - is expected to gain momentum resulting in a shift in negotiating power between landlords and tenants in the central core submarkets. The extent of improvements across 11 all San Diego office submarkets in 2013 will depend heavily on
Fig. 1

Fig. 1

Net Change in Jobsby by Industry Industry Sector Net Change in Jobs Sector
San Diego County, between Oct. 2011 & Oct. 2012 San Diego County, between Oct. 2011 & Oct. 2012 -4,000 -2,000 0 0 3,100 -1,900 -1,400 300 200 900 8,100 500 3,600 5,100 200 -600 Hotels Medical Office Industrial 5,400 Retail Office 2,000 4,000 6,000 8,000 10,000

Mining & Logging Construction Manufacturing Wholesale Retail Transp. & Wareh. & Util. Information Financial Activ. Prof. & Bus. Serv. Educ. Serv. Health Care Leisure & Hosp. Other Serv. Govt.

Between October 2011 and 2012, total nonfarm increased by 23,500 jobs, or 8,100 1.9%. Professional and business services posted the sional and October business services postedemployment the greatest year-over gain, adding jobs. Administrative and support and greatest year-over gain, adding 8,100 jobs. Administrative and support and waste services (up 6,300) contributed to more than 75% of the job growth in this waste services (up 6,300) contributed to more than 75% of the job growth in this sector. Professional, scientific, and sector. Professional, scientific, and technical services added 1,700 jobs, followed by a gain of 100 jobs in management of companies and enterprises. Nine technical services 1,700 jobs, followed by a gain of 100 jobs in management of educational companies and enterprises. other sectors also added jobs over the added year. The notable came from leisure and hospitality (up 5,100); retail (up 5,400); and health services (up Nine other sectors also added reported jobs over the year. notable came from leisure hospitality 5,100); retail 4,100); and construction (up 3,100). Three industries year-over jobsThe losses: manufacturing (down 1,900), and wholesale (1,400) (up and government (down 600). (up 5,400); educational and health services (up 4,100); and construction (up 3,100). Three industries reported Source: U.S. Department of Labor, Bureauwholesale of Labor Statistics Labor Dept. year-over jobs losses: manufacturing (down 1,900), (1,400) and government (down 600).

Between October 2011 and October 2012, total nonfarm employment increased by 23,500 jobs, or 1.9%. Profes-

Source: U.S. Department of Labor, Bureau of Labor Statistics Labor Dept.

improvements in the employment market and tenant confidence to make long-term leasing decisions. Despite the many concerns landlords and tenants are facing – fiscal cliff, taxes, unresolved issues in Europe among many others – the national and local employment markets continue to improve, albeit slowly. The San Diego office market is following the same trend, a slow and steady improvement, as evidenced by decreasing countywide
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vacancy and improved leasing. Further improvement depends heavily on job growth. • Employment Forecast: San Diego’s employment market has improved notably over the last year, adding a total of 23,500 jobs of which 8,100 were in professional and business services sector outpacing the total annual job growth in neighboring Southern California metros between October

2011 and October 2012 (Figure 1).2 As a result, the unemployment rate in San Diego has dropped 1.2 percentage points to 8.6% over the last year compared to a one percentage point decrease in the national unemployment rate.3 San Diego’s total employment is forecasted to increase 1.7% in 2013.4 All sectors except government and natural resources and mining are forecasted to add jobs in 2013 with growth rates ranging between 0.2% and 3.2%. Office employment is forecasted to grow 2.7% or 7,770 office jobs in 2013 (Figure 3). Financial
Fig. 2

activities and professional and business services jobs – the main office tenants – are forecasted to grow 2.1% and 2.9% respectively. The countywide unemployment rate is forecasted to continue the downward trend in 2013, positively affecting office leasing. • Leasing: Evaluating office leasing activity countywide for all classes in 20125, activity was the highest in Central County totaling 75% of the total SF leased countywide. North County accounted for 15% and South County for 10% of the total leases signed. 6

The top five most sought-after submarkets in 2012 based on leases signed were Sorrento Mesa, UTC, Mission Valley, Kearny Mesa and Carlsbad (Figure 4). These five submarkets combined accounted for 54% of the total SF leased in 2012. Top 10 submarkets combined accounted for 84% of the total leasing activity, indicating that of 32 office submarkets countywide, tenant demand is concentrated in the top 10. Eight of the top 10 submarkets are located in Central County. Central County: Leasing activity in Central County was led by Class A and B leasing. Class A leasing accounted for 46.2% and Class B for 46.1% of the total SF leased in 2012. As a result, Class A direct vacancy has decreased from 10.8% to 9.1% over the last year (3Q113Q12) and is currently below the seven-year average of 12.1%. Class B direct vacancy has decreased from 19.0% to 16.6% during the same time period and remains above the seven-year average of 15.3%. Overall direct vacancy rate in Central County for all classes was

Office Jobs in San Diego, CA MSA
Fig. 2
25 20 15 10 5 0 (5) (10) (15) (20) 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Between 1993 and 2007 San Diego County added a total of 118,800 office jobs (annual average of 7,900 office jobs over 15 years).

Office Jobs in San Diego, CA MSA
Net Change in Jobs % Change
Between 2008 and 2010 San Diego County lost a total of +11,600 28,700 office jobs.

Thousands of Jobs

12% 10%
+28,600

8% 6% 4% 2% 0% -2% -4% -6%

2009

2010

2011

2012

2013f

2014f

San Diego-Carlsbad-San Marcos, CA CA Metropolitan Statistical Area (MSA). San Diego-Carlsbad-San Marcos, Metropolitan Statistical Area (MSA). Office Jobs include Profesional & Business Services Services and Financial ActivitiesActivities Office Jobs include Profesional & Business and Financial
Source: Moody’s Analytics. (f) forecasted. Forecast last updated 9/20/2012.

2015f

(25)

-8%

12

Source: Moody’s Analytics. (f) forecasted. Forecast last updated 9/20/2012 Cassidy Turley San Diego | www.CassidyTurley.com/SanDiego

San Diego Office Forecast
Fig. 3

Employment Summary: San Diego-Carlsbad-San Marcos CA, MSA
Current Employment* Number of Jobs Added or Lost inThousands** 2012 -0.01 0.93 -1.54 -2.19 5.12 0.57 -0.48 1.53 6.24 1.16 4.04 3.29 -0.01 -1.83 16.82 2013 0.00 1.71 0.22 0.06 2.00 0.54 0.17 1.45 6.25 0.61 4.11 4.91 0.87 -1.08 21.82 2014 0.00 2.92 1.19 0.50 1.53 0.54 0.45 1.17 7.98 0.71 4.48 4.91 0.73 3.95 31.06 2015 0.00 3.41 1.43 0.71 1.32 0.62 0.60 1.84 9.84 0.94 5.23 5.74 0.90 4.55 37.13 2012 -1.4% 1.7% -1.7% -5.4% 3.9% 2.2% -2.0% 2.3% 2.9% 4.3% 3.3% 2.1% 0.0% -0.8% 1.4% Annual Growth Rate (%) 2013 -0.4% 3.0% 0.2% 0.2% 1.5% 2.0% 0.7% 2.1% 2.9% 2.2% 3.2% 3.1% 1.8% -0.5% 1.7% 2014 -0.1% 5.0% 1.3% 1.3% 1.1% 2.0% 1.9% 1.7% 3.6% 2.5% 3.4% 3.0% 1.5% 1.8% 2.4% 2015 0.2% 5.6% 1.5% 1.8% 0.9% 2.2% 2.5% 2.6% 4.2% 3.2% 3.9% 3.4% 1.9% 2.0% 2.9% Total Employment 400 58,300 90,900 39,200 138,100 27,000 23,900 67,700 222,700 28,000 126,400 161,600 47,300 230,100 1,261,600 % of Total Employment 0.0% 4.6% 7.2% 3.1% 10.9% 2.1% 1.9% 5.4% 17.7% 2.2% 10.0% 12.8% 3.7% 18.2% 100.0%

Employment Sector
Natural Res. & Mining Construction Manufacturing Wholesale Trade Retail Trade Transp., Wareh., & Util. Information Financial Activ. Prof. & Bus. Serv. Educational Serv. Health Care & Social Assist. Leisure & Hospitality Other Services Government Total Nonfarm Employment

* Current Employment as of October, 2012. Source the U.S. BLS and the Labor Market Information Division of the California EDD. **Moody’s Analytics; economy.com; forecast last updated 9/20/2012.

Office Employment
Current Employment* Number of Jobs Added or Lost inThousands** 2012 1.53 6.24 7.77 2013 1.45 6.25 7.70 2014 1.17 7.98 9.15 2015 1.84 9.84 11.68 2012 2.3% 2.9% 2.8% Annual Growth Rate (%) 2013 2.1% 2.9% 2.7% 2014 1.7% 3.6% 3.1% 2015 2.6% 4.2% 3.9%

Employment Sector
Financial Activ. Prof. & Bus. Serv.

Total Employment 67,700 222,700 290,400

% of Total Employment 23.3% 76.7% 100.0%

13

Total Office - Using Employment

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Fig. 4

San Diego County - All Classes – Ranked by SF Leased - 2012YTD
Highest Leasing Activity Rank Submarket 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Sorrento Mesa UTC Mission Valley Kearny Mesa Carlsbad Del Mar Downtown Eastgate Rancho Bernardo Torrey Pines Scripps Sorrento Valley San Marcos Encinitas Sorrento Mesa National City Governor Oceanside Escondido Solana Beach
Source: Cassidy Turley San Diego.

Top Office Submarkets By Leasing Activity
Transactions By Building Class Class A B C Total Submarket 46.3% 44.3% 7.4% 100%

to 19.2% over the last year (3Q113Q12) and is below the seven-year average of 20.8%. Class B direct vacancy has inched up from 24.0% to 24.6% during the same time period and is above the seven-year average of 20.3%. Overall direct vacancy rate in North County for all classes was 22.0% as of 3Q12, 1.6 percentage points lower than a year ago and above the seven-year average of 20.3%. Carlsbad, the largest North County office submarket (4.1 million SF) is expected to benefit from tightening supply in North County much sooner than other submarkets. The coastal corridor from Del Mar to Carlsbad is one of the County’s historically strongest suburban office markets. Additionally, Carlsbad is strategically positioned to benefit from the high cost of space in Del Mar located in Central County and the endless stream of northbound tenants. Expect gradual improvements in leasing and occupancy throughout 2013 in North County. South County: Leasing activity in South County was led by Class

13.1% as of 3Q12, 1.9 percentage points lower than a year ago and below the seven-year average of 13.6%. As the gap between Class A and Class B product continues to tighten supported by strong leasing velocity, expect to see an

increase in asking rents in 2013. North County: Leasing activity in North County was also led by Class A and B leasing. Class A leasing accounted for 42.2% and Class B for 39.2% of the total SF leased in 2012. As a result, Class A direct vacancy has decreased from 23.6%
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14

San Diego Office Forecast
A and B leasing. Class A leasing accounted for 53.1% and Class B for 39.0% of the total SF leased in 2012. As a result, Class A direct vacancy has decreased from 19.2% to 17.6% over the last year (3Q113Q12) and remains above the seven-year average of 17.3%. Class B direct vacancy has increased from 19.7% to 20.3% during the same time period and is above the seven-year average of 15.7%. Overall direct vacancy rate in South County for all classes was 18.4% as of 3Q12, 0.3 percentage points higher than a year ago and above the seven-year average of 15.1%. Downtown, the largest South County submarket (9.9 million SF), continues to struggle with a high vacancy rate and is exposed to a substantial amount of tenant lease expirations within the next three years. Between four tenants – Sempra, The City of San Diego, Liberty Mutual and ESET – we will see a total of over 950,000 SF of tenant rollover. The largest landlord, Irvine Company, owner of six of the 11 downtown San Diego Class A buildings, remains an aggressive, well-funded owner and offers
Fig. 5
Property Multiple Buildings* Bridge Pointe Corporate Centre II Innovation Corporate Center Corporate Plaza I Centerside I

Key Office Lease Transactions 2012 YTD
SF 270,343 94,543 69,362 69,000 54,728 Tenant Qualcomm Inc. ServiceNow, Inc. EnXco, Inc. Latham & Watkins LLP United Healthcare Transaction Type Submarket New & Renewal New Expansion New Renew Sorrento Mesa Eastgate Rancho Bernardo Del Mar Mission Valley

*Sorrento Towers North - West, 119,381 SF. Renewal ~ San Diego Tech Center, 76,404 SF; New ~ Scripps Wateridge Corporate Plaza, 74,558 SF. Source: Cassidy Turley San Diego. 2012YTD as of 3Q12.

Fig. 6

San Diego County Office, All Classes excl. Sublease
Net Absorption Thousands of SF 3,500 Total Completions

Net Absorption vs. Completions Fig. 6 Net Absorption vs. Completions
San Diego County Office, All Classes excl. Sublease

2,500

1,500

500

(500)

(1,500)

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012e

2013f

Source: Cassidy Turley San Diego. (e) estimated; (f) forecasted by Cassidy Turley San Diego & The Corky McMillin Center for Real Estate.

15

generous tenant improvements, leasing incentives and concessions in an effort to attract, retain, relocate and/or grow their existing tenant base. Competition for quality

Source: Cassidy Turley San Diego. (e) estimated; (f) forecasted by Cassidy Turley San Diego & The Corky McMillin Center for Real Estate.

tenants will only increase in 2013. Net Absorption: Countywide annual net absorption for all classes was 460,958 SF as of 3Q12

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Fig. 7

Office Projects Under Construction
SF 417,000 248,882 123,429 63,941 57,476 33,000 Address 4707 Executive Dr. 10385 Vista Sorrento Pky. 5200 Research Pt. 2600 Via De La Valle 4002 W Vista Way 662 Encinitas Blvd. Class A A A A A B Submarket UTC Sorrento Mesa UTC Del Mar Oceanside Encinitas

San Diego County Office, All Classes, as of Nov. 2012
Property La Jolla Commons II FBI San Diego La Jolla Corporate Campus - Illumina Flower Hill Professional Center Tri-City Medical Quail Garden Corporate Center

Source: Cassidy Turley San Diego & CoStar Group Inc.

compared to 260,876 SF at the same time last year. 7 To put these numbers in perspective, the annual net absorption before recession averaged at 997,000 SF and during recession tenants returned an average of 633,000 SF. The annual net absorption averaged 646,000 SF in post-recession years (2010 and 2011) which means the current net absorption levels are at 65% of the pre-recession levels. In 2013, countywide net absorption for all classes is expected to be slightly over 600,000 SF (Figure 6). Flight-to-quality and renewals within

the 5,000 to 20,000 SF range will continue to be the main drivers of leasing activity, with Class A leading the way followed by the well located Class B buildings, continuing the post-recession trend. The current Class A net absorption levels are at 87% of the pre-recession levels. Tenants currently in the market are looking for 2.5 million SF over the next 24 months with 1.7 million SF in Central and South Counties combined and 800,000 SF in North County. The most active tenants countywide are from the technology, life sciences, financial activities, educational services, and
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professional and business services sectors. While not all of the current tenants in the market will transact in 2013, leasing activity is set to be positive supported by limited new construction and improved hiring. • Future Inventory: Limited new construction countywide has played an important role in the current office market recovery by enabling the office market to regain its footing. Of six projects totaling 943,728 SF currently under construction combined, four projects or 853,252 SF are 100% pre-leased (Figure 7). While developers are breaking ground

16

San Diego Office Forecast
on build-to-suit projects, the consensus is that a majority of the developers are evaluating building speculative office space but are not ready to take the risk. • Vacancy: Total – Countywide total vacancy for all classes, including sublease space, was 18.1% in the third quarter, 3.5 percentage points lower than the peak rate of 21.6% recorded at the end of the recession (3Q09). The countywide total vacancy is forecasted to decrease from an average annual percentage of 18.0% in 2012 to 17.4% by the end of 2013, but will remain above the 10-year average of 16.4% (Figure 8). Total vacancy ranges between 8% and 39.3% across 32 office submarkets indicating that the negotiating power varies by submarket.8 Direct – The countywide direct vacancy rate is forecasted to decrease from 15.2% in 2012 to 14.8% by the end of 2013 and will remain above the 10-year average of 13.0% (Figure 8). 17 By Class – Class A leasing has
Source: Cassidy Turley San Diego. 2012YTD as of 3Q12.

Fig. 8

San Diego County Office, All Classes

Vacancy Rate

Source: Cassidy Turley San Diego. 10-Year Average (2003-2012). (e) estimated; (f) forecasted by Cassidy Turley San Diego & The Corky McMillin Center for Real Estate.

Fig. 9

San Diego County Office, excl. Sublease

Direct Vacancy Rate by Class

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been positive for 13 consecutive quarters (3Q09-3Q12) during which a combined 2.7 million SF have been absorbed countywide. As a result, Class A direct vacancy has recorded the most improvements since the end of the recession by decreasing 6.9 percentage points to 12.1% (3Q12). The current Class A direct vacancy is below the 8-year average of 13.7%. Note that direct Class A vacancy is as tight as 1.1% in Eastgate and as high as 40.7% in Chula Vista-East; however, the top 10 tightest Class A submarkets are located in Central County and all recorded below 10% direct vacancy in 3Q12. Class B vacancy has decreased 0.1 percentage points to 18.5% and Class C vacancy has increased 2.4 percentage points to 15.6% since the end of the recession (2009). It will take several years for Class B and C vacancy rates to fall below the 8-year average of 14.8% and 12.1% respectively (Figure 9). • Asking Rents: The overall countywide monthly average asking rent for all classes was $2.23 per month full service (FS)

Fig. 10

Weighted Average Monthly Asking Rent (FS)
San Diego County Office, All Classes

Source: Cassidy Turley San Diego. (e) estimated; (f) forecasted by Cassidy Turley San Diego & The Corky McMillin Center for Real Estate.

in 3Q12 which is 12% below the pre-recession annual average. Year-over-year (3Q12 vs. 3Q11), average countywide rent increased $0.02, indicating that rents have stabilized across all classes. The current Class A average asking rent at $2.68 per month FS and is 9% below the pre-recession average yet has increased 3.5% from last year (3Q11). As the Class A market approaches peak rents, tenants will shift focus to well-located Class B buildings.

Class B and C asking rents have remained unchanged from a year ago. However, as Class A supply continues to tighten in 2013 and begins to justify an increase in Class A rents beyond core submarkets, demand for Class B space is bound to increase driven by tenants priced out of the Class A market. Overall countywide average rent is expected to increase between 2% and 3% in 2013 supported by healthy leasing activity led by

18

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San Diego Office Forecast
Central County as well as limited new construction (Figure 10). Some of the county’s largest landlords have already been increasing rents slightly since the beginning of 2012, a trend that is expected to strengthen in 2013 (Figure 11). Conditions for landlords of the best buildings located in prime submarkets will be much more favorable than the conditions for landlords of older office buildings located in secondary submarkets. Understandably, recovery does not feel tangible when the landlord is struggling to retain tenants in a flight-to-quality market. Many existing older buildings will need to increase efficiencies and retrofit new systems in order to compete effectively. While concessions have peaked in most submarkets, tenants still have an opportunity to take advantage of reduced concessions, with the exception of Del Mar Heights and surrounding prime submarkets. In the prime submarkets, the window of opportunity for tenants to secure the best deals in the best buildings
Fig. 11

Top 10 Largest Office Landlords & Tenants in 2012
San Diego County
Rank 1 2 3 4 5 6 7 8 9 10 Top 10 Tenants Tenants Qualcomm, Inc. City of San Diego SONY Motorola AT&T Cardinal Health, Inc Sempra Energy Bridgepoint Education GEICO ResMed Inc.

Top 10 Landlords Rank 1 2 3 4 5 6 7 8 9 10 Landlord The Irvine Company Kilroy Realty Corporation The Blackstone Group Arden Realty, Inc. RREEF America Alexandria Real Estate Equities, Inc. TA Associates Realty Hines Prudential Real Estate Investors MIG Real Estate

Rankings based on SF representation. Source: Cassidy Turley San Diego & CoStar Group Inc.

is closing, a trend that is expected to strengthen in Central County. For other submarkets, dynamic change will come to the market when mid-size and smaller companies, representing the majority of office tenants in San Diego, feel more confident about making real estate decisions. • Sales Activity: The total sales volume of office properties of all sizes countywide was $1,148.3 million in 2012, a 10.5% decrease compared to 2011.9 Top buyers in San Diego County in 2012 based on total sales volume were BCL Inc.,
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Beacon Capital Partners, Emmes Asset Management Company, Cruzan | Monroe & Cigna, The Irvine Company, and Lincoln Property Company (Figure 12). Top sellers were TA Associates, Pacific Office Properties, MPG Office Trust Inc., GE Investment Corporation, Wereldhave USA, Inc., TIAA-CREF, and Nomura CDO. The average price per-square-foot was $249 in 2012 compared to $221 in 2011. The average cap rate increased slightly to 7.61% in 2012 from 6.84% recorded in 2011. In 2013, the demand for Class A

19

Fig. 12

Key Office Sale Transactions 2012YTD
SF 641,693 553,715 306,750 202,913 359,218 Seller/Buyer MPG Office Trust Inc./ Beacon Capital Partners GE Investment Corporation / Emmes Asset Management Company Wereldhave USA, Inc. / Cruzan | Monroe & CIGNA TIAA - CREF / The Irvine Company Nomura CDO / Lincoln Property Company Transaction Amount $152,500,000 $135,000,000 $121,000,000 $52,000,000 $49,000,000 Submarket Sorrento Mesa Downtown Downtown Mission Valley Downtown

Property San Diego Tech Center Columbia Center DiamondView Tower Centerside I 600 B Street

Source: Cassidy Turley San Diego. 2012YTD as of 3Q12.

assets with well-positioned quality tenants in place will continue to outpace supply. The lack of available product will keep the lid on transaction volume instead of a lack of available capital. In the short-term (2013), recovery will be more evident in prime Central County submarkets such as Del Mar Heights, Sorrento Mesa, UTC, Kearny Mesa and Mission Valley, while other submarkets such as a majority of the South County submarkets, will remain in status quo throughout 2013. Consequently, overall office market performance will remain mixed as it will be well into 2014 before the recovery is felt in all submarkets

across the county. The next year will be about gaining leasing traction and working on strengthening market fundamentals while adjusting to a decreasing average tenant footprint. More evident improvement and growth across all submarkets is expected in 2014 and 2015.
1. Pre-recession 2006 & 2007; recession 2008 & 2009; postrecession 2010 & 2011. Cassidy Turley San Diego. Based on net absorption. 2. U.S. Department of Labor, Bureau of Labor Statistics Labor Dept. November 16, 2012. 3. www.bls.gov San Diego: October 2011 vs. October 2012. National: November 2011 vs. November 2012 4. Moody’s Analytics; economy.com; forecast last updated 9/20/2012. 5. Based on Cassidy Turley San Diego lease comparables total SF leased as of 12-6-2012 6. Based on lease comparables from 1-1-2012 to 12-7-2012. 7. Cassidy Turley San Diego tracks office inventory quarterly that includes multi-tenant and single tenant buildings. Government and medical buildings are not included. 8. Data as of 3Q12. 9. Real Capital Analytics, Inc. Based on properties and portfolios$5 million and greater. Cassidy Turley San Diego | www.CassidyTurley.com/SanDiego

20

San Diego Industrial Forecast

21
Cassidy Turley San Diego | www.CassidyTurley.com/SanDiego

San Diego Industrial Forecast
Uptick in Demand Expected in 2013
The U.S. economy has been growing at an average annual pace of 2.2% in 2012 and is forecasted to grow 1.4% in 2013.1 The local economy has been growing at an average annual pace of 1.7% in 2012 and is forecasted to grow 1.5% in 2013.2 The San Diego industrial market has been improving in parallel with the national and local economies and is expected to stay on course while maintaining moderate yet steady improvements in 2013. Progress in the first half of 2013 is anticipated to be more subdued compared to the second half of the year as businesses/tenants receive more certainty around the future tax liabilities. Some indicators tracking the U.S. economy and directly affecting the demand for industrial space nationally and locally have improved in 2012; however, some indicators have not progressed. Consumer Confidence: All three major indexes measuring consumer
Fig. 1

Institute of Supply Management (ISM) Index Institute of Supply Management (ISM) Index
Fig. 1

60 55 50 45 40 35 30

Expansion Contraction

Feb-08

Feb-09

Feb-10

Feb-11

Nov-08

May-08

May-09

Nov-09

May-10

May-11

Feb-12

May-12

Aug-08

Aug-09

Aug-10

Aug-11

Aug-12

Nov-07

Nov-10

Source: Institute for Supply Management. http://www.ism.ws/index.cfm Source: Institute for Supply Management.
http://www.ism.ws/index.cfm

Fig. Fig. 2 2 Net

San Diego County, between Oct. 2011 & Oct. 2012 San Diego County, between Oct. 2011 & Oct. 2012 -4,000 -2,000 0 0 3,100 2,000 4,000 6,000 8,000

NetChange Change Jobs by Industry Sector inin Jobs by Industry Sector
10,000

Mining & Logging Construction Manufacturing Wholesale Retail Transp. & Wareh. & Util. Information Financial Activ. Prof. & Bus. Serv. Educ. Serv. Health Care Leisure & Hosp. Other Serv. Govt.

-1,900
-1,400 300 200 900

Industrial 5,400

Nov-11

Retail
Office 8,100

500 3,600 5,100 200 -600

Medical Office

Hotels

23

more thanand 75% of the job growth in this sector.employment Professional, scientific, and services added 1,700 jobs, followed by a gain services of Between October 2011 October 2012, total nonfarm increased by technical 23,500 jobs, or 1.9%. Professional and business 100 jobs in management of companies and Administrative enterprises. Nine other sectorsand also waste added services jobs over the The notable came leisure posted the greatest year-over gain, adding 8,100 jobs. and support (upyear. 6,300) contributed to from more than 75% and (up 5,100); retail scientific, (up 5,400); educational and health services (up 4,100); and construction (upof 3,100). Two in industries of the job growth inhospitality this sector. Professional, and technical services added 1,700 jobs, followed by a gain 100 jobs management reported year-over jobs and government (down 600). came from leisure and hospitality (up 5,100); of companies and enterprises. Ninelosses: other manufacturing sectors also (down added1,900) jobs over the year. The notable retail (up 5,400); educational and health services (up 4,100); and construction (up 3,100). Two industries reported year-over jobs losses: Source: U.S.600). Department of Labor, Bureau of Labor Statistics Labor Dept. manufacturing (down 1,900) and government (down

Between October 2011 and October 2012, total nonfarm employment increased by 23,500 jobs, or 1.9%. Professional and business services posted the greatest year-over gain, adding 8,100 jobs. Administrative and support and waste services (up 6,300) contributed to

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Source: U.S. Department of Labor, Bureau of Labor Statistics Labor Dept.

Nov-12

confidence, including the benchmark Consumer Confidence Index, the Present Situation Index and the Expectations Index, reported an improvement in November 2012. The Consumer Confidence Index increased to 73.7 from 73.1 in October and is now at its highest level in more than 4.5 years (76.4 Feb. 2008).3 Retail Sales: Retail and food services sales were up 3.7% in November 2012 compared to last year.4 Note that consumer spending accounts for 70% of all economic activity nationwide and retail sales account for one third of the 70%.5 Retail sales are closely linked to the demand for distribution centers. ISM Index: Economic activity in the manufacturing sector contracted in November following two months of modest expansion, while the overall economy grew for the 42nd consecutive month. The index registered 49.5%, a decrease of 2.2 percentage points from October’s reading of 51.7%, indicating contraction in manufacturing for the fourth time in the last six months (Figure 1). A reading above 50%

Fig. 3

Industrial Jobs in San Diego, CA MSA Fig. 3 Industrial Jobs in San Diego, CA MSA
Net Change in Jobs % Change 8% 6% 5
+2,832 +4,116

Thousands of Jobs

10

4% 2%

0

0% -2% -4%

(5)

(10)

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013f

2014f

San Diego-Carlsbad-San Marcos, CA Metropolitan Statistical Area (MSA). Industrial Jobs include Manufacturing & Wholesale Trade.
San Diego-Carlsbad-San Marcos, CA Metropolitan Statistical Area (MSA). Industrial Jobs include Manufacturing & Wholesale Trade. Source: Moody’s Analytics. (f) forecasted. Forecastlast last updated 9/20/2012. Source: Moody’s Analytics. (f) forecasted. Forecast updated 9/20/2012.

indicates that the manufacturing economy is generally expanding; below 50% indicates that it is generally contracting. This month’s index reflects the lowest level since July 2009.6 Seven industries reported growth in new orders and nine reported a decrease in November. The jury is still out in terms of which direction the index will move next and what effects the slowdown of economic activity in the manufacturing sector will have on San Diego’s industrial market. In San Diego, the most closely
Cassidy Turley San Diego | www.CassidyTurley.com/SanDiego

watched indicator is employment as demand for commercial real estate including industrial space is the most influenced by improvements in local employment among other factors. Employment Forecast: San Diego’s employment market has improved notably over the last year, adding a total of 23,500 jobs of which 8,100 were in the professional and business services sector outpacing the total annual job growth in neighboring Southern California metros between October 2011 and October 2012 (Figure 2).7 As

2015f

(15)

Between 1994 and 2001 San Diego County added a total of 24,712 industrial jobs (an annual average of 3,089 industrial jobs over 8 years)

-6%
-14,426 -16,050

-3,126

-8% -10%

24

San Diego Industrial Forecast
a result, the unemployment rate in San Diego has dropped 1.2 percentage points to 8.6% over the last year compared to one percentage point decrease in the national unemployment rate.8 San Diego’s total employment is forecasted to increase 1.7% in 2013.9 All sectors except government, natural resources and mining are forecasted to add jobs in 2013 with growth rates ranging between 0.2% and 3.2%. Industrial employment is forecasted to grow 0.2% in 2013 (Figure 3). Manufacturing and wholesale trade – the primary industrial tenants – are forecasted to grow slightly at the same speed of 0.2%. The countywide unemployment rate is forecasted to continue the downward trend in 2013. Leasing: Evaluating industrial leasing activity countywide for all product types in 201210, activity was the highest in Central County totaling 46% of the total SF leased countywide. North County accounted for 34.7% and South County for 18.7% of the total leases signed. The top five most sought-after submarkets in 2012 were Otay Mesa, Vista, Miramar, Carlsbad and Sorrento Mesa (Figures 4 and 5). These five submarkets combined accounted for
Fig. 4

San Diego County - All Classes – Ranked by SF Leased - 2012YTD
Highest Leasing Activity Rank Submarket 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Otay Mesa Vista Miramar Carlsbad Sorrento Mesa Kearny Mesa East County San Marcos Escondido Oceanside Poway Sorrento Valley Chula Vista Rancho Bernardo Scripps National City Carmel Mountain Morena Downtown Mission Valley
Source: Cassidy Turley San Diego. 2012YTD as of 12/10/12.

Top Industrial Submarkets By Leasing Activity
Transactions By Building Class Class R&D MFG IMT DIST Other Total Submarket 36.5% 23.6% 23.0% 11.1% 5.9% 100%

60.6% of the total SF leased in 2012. Top 10 submarkets combined accounted for 85.9% of the total leasing activity, indicating that of 25 industrial submarkets countywide, tenant demand is concentrated in the top 10 submarkets. The most space (68% of the total SF leased) in 2012 was leased by tenants representing manufacturing, wholesale, technology and
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transportation, warehousing and utilities industry sectors. In 2013, expect the best demand to come from tenants representing growing San Diego industries such as life science, clean tech, wireless communications, medical device and action sports/lifestyle among others. • North County: Leasing activity in North County was led by

25

manufacturing tenants accounting for 44% of the total space leased in 2012. Distribution space accounted for 22%, R&D accounted for 20% and IMT accounted for 12% of the total SF leased in 2012. The overall direct vacancy rate in North County for all product types was 8.7% (3Q12) compared to 11% last year (3Q11), and is below the seven-year average of 9.6%. Leasing activity as measured by net absorption has been positive for the last three years. Tenants absorbed 836,000 SF in the first three quarters of 2012, a level not seen since 2007. Current annual absorption is at 85% compared to an annual average of 984,000 SF during the pre-recession years (2006 and 2007). • Central County: Leasing activity in Central County was led by R&D (34% of the total) followed by distribution space (30%), manufacturing space (14%) and IMT space (13%) in 2012. The overall direct vacancy rate in Central County for all product types was 8.1% (3Q12) compared to 8.7% last year (3Q11), yet remains above the seven-year average of 7.3%. Leasing activity as measured by net absorption has been positive for the last three years. Tenants

absorbed 652,000 SF in the first three quarters of 2012. Current annual absorption is at 63% compared to an annual average of 1.03 million SF during the pre-

recession years (2006 and 2007). • South County: Leasing activity in South County was led by distribution space accounting for

Fig. 5
Property

Key Industrial Leases 2012YTD
SF 257,972 124,068 120,221 78,744 69,900 Tenant Imperial Toys Pacific World Corporation SAIC Cymer, Inc. CoreLogic Solutions, LLC Transaction Type New New Renew Expansion New Submarket Otay Mesa Otay Mesa Vista Rancho Bernardo Scripps Ranch

Siempre Viva Business Park Bldg. 9 Siempre Viva Business Park Bldg. 14 Oak Ridge Corporate Centre Rancho Bernardo Distribution Center 10277 Scripps Ranch Blvd.

Source: Cassidy Turley San Diego. 2012YTD as of 3Q12.

Fig. 6

San Diego County Industrial, All Product Types excl. Sublease
Net Absorption
Thousands

Fig. 6 San Diego County Industrial, All Product Types excl. Sublease
Annual Completions

NetNet Absorption vs. Completions Absorption vs. Completions

6,000 4,000 2,000 0

-2,000
-4,000 -6,000

2004

2005

2006

2007

2008

2009

2010

2011

2012e

2013f

Source: Cassidy Turley San Diego. (e) estimated; (f) forecasted by Cassidy Turley San Diego.
Source: Cassidy Turley San Diego. (e) estimated; (f) forecasted by Cassidy Turley San Diego.

26

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San Diego Industrial Forecast
San Diego County Industrial, All Product Types
14%
9-Yr Total Vacancy incl. Sublease Avg. 9.8% 12% 10.6% 10% 12.7% 11.9% 11.2% 10.5% 9.8% 8.8% 8% 9.2%

Fig. San 7 Diego County Industrial, All Product Types

Fig. 7

Direct Vacancy Rate Direct Vacancy Rate

10.1%

8.0%
7.0% 7.5%

6%

year (3Q11), yet remains above the seven-year average of 11.1%. Leasing activity as measured by net absorption has been positive for the last three years. Tenants absorbed 387,000 SF in the first three quarters of 2012. Current annual absorption is at 65% compared to an annual average of 591,000 SF during the pre-recession years (2006 and 2007). Net Absorption: Countywide annual net absorption for all product types was 1.9 million SF as of 3Q12 compared to negative 1,087 SF the same time last year.11 Countywide net absorption has been positive for five consecutive quarters, averaging 570,000 SF per quarter. To put these numbers in perspective, the annual net absorption before the recession averaged at 2.8 million SF and during the last recession tenants returned an average of 1.9 million SF. The annual net absorption averaged 831,000 SF in post-recession years (2010 and 2011) which means the current net absorption levels are at 67% of the pre-recession levels. In 2013, countywide net absorption for all classes is expected to be slightly over 2.2 million SF (Figure 6). Flight-to-quality and renewals within

9-Yr Average 8.3% (2004 -2012) 4%
2004 2005 2006 2007 2008 2009 2010 2011 2012e 2013f

Fig. 8

Direct Vacancy Rate by Product Type San Vacancy Diego County Industrial, excl. Sublease Fig. 8 Direct Rate by Product Type
Source: Cassidy Turley San Diego. (e) estimated; (f) forecasted by Cassidy Turley San Diego .

Source: Cassidy Turley San Diego. (e) estimated; (f) forecasted by Cassidy Turley San Diego

San Diego County Industrial, excl. Sublease
R&D MFG IMT 13.2% 12.0% 11.9% DIST

15% 11.9% 10.0% 9.0% 6.5% 5% 6.4% 5.0% 8.0% 6.5%

10%

8.8%

0%

7-Yr Direct Vacancy Avg. R&D 11.1%; MFG 6.5%; IMT 9.5%; DIST 9.8% 2006 2007 2008 2009 2010 2011 2012YTD

Source: Cassidy Turley San Diego. 2012YTD as of 3Q12.
Source: Cassidy Turley San Diego. 2012YTD as of 3Q12.

27

81% of the total SF leased in 2012. Manufacturing space accounted for 8% and IMT for 5%. The overall

direct vacancy rate in South County for all product types was 11.2% (3Q12) compared to 12.3% last
Cassidy Turley San Diego | www.CassidyTurley.com/SanDiego

Fig. 9

Total Vacancy Rates as of 3Q12
Select West Coast Markets, All Product Types, incl. Sublease

the 5,000 to 30,000 SF range will continue to be the main drivers of leasing activity, with manufacturing space leading the way. Tenants will continue to take advantage of current market trends by upgrading their facility to larger, higher-quality spaces or prime locations, or both. The majority of the industrial inventory in San Diego was built before 2000 leaving tenants with a relatively limited supply of new buildings. Tenants currently in the market are looking for more than 4.7 million SF countywide, with 2.6 million SF in North County and 2.1 million SF in the Central and South Counties combined over the next 24 months. The most active tenants countywide are from the local businesses representing manufacturing, life science, transportation, warehousing and utilities industry sectors. Currently, there are 47 tenants in the market looking for manufacturing space accounting for 40% of the total SF requirement. While not all of the current tenants in the market will transact in 2013, leasing activity is set to be positive supported by lack of new construction and improved hiring. Future Inventory: Limited new

Fig. 9

Select West Coast Markets, All Product Types, incl. Sublease
Orange County** Salt Lake City San Francisco Los Angeles San Jose Albuquerque Denver Portland* Oakland/East Bay San Diego Phoenix Las Vegas 10.5%

Total Vacancy Rates as of 3Q12

Sacramento
0% 5% 10% 15%

Source: Cassidy Turley. *Portland-Vancouver-Beaverton, OR-WA. **Anaheim - Santa Ana, CA.

construction countywide has played an important role in the current industrial market recovery by enabling the industrial market to regain its footing. There are no projects scheduled for completion in 2013 as the new speculative construction remains at a standstill (Figure 6). The consensus is that developers are not ready to build unless there is a committed tenant.

Source: Cassidy Turley. *Portland-Vancouver-Beaverton, OR-WA. **Anaheim - Santa Ana, CA.

percentage points lower than the peak rate of 12.7% recorded in 4Q09. The countywide total vacancy is forecasted to decrease further from 10.5% in 2012 to 9.2% by the end of 2013 and is expected to fall below the 10-year average of 9.8% (Figure 7 and 9).12 • By Product Type – Since the end of the recession (2009), countywide annual net absorption has been positive for all product types except for R&D, which slightly dipped into the red in 2011. As a result, all product types have recorded decreasing vacancy. Direct vacancy has decreased 3.0

Vacancy: The countywide total vacancy for all product types, including sublease, was 10.5% in the third quarter. Vacancy has been decreasing for five consecutive quarters and is currently 2.2
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28

San Diego Industrial Forecast
percentage points for IMT, 1.9 percentage points for distribution, 1.5 percentage points for manufacturing, and 1.3 percentage points for R&D from 2009 to 2012. Furthermore, direct vacancy for IMT space decreased to below the seven-year average in 2012. Direct vacancy for manufacturing space was the same as the seven-year average as of 3Q12, indicating that demand has recovered quite nicely (Figure 8). Asking Rents: Over the last 10 quarters, the countywide monthly asking rent for all product types has remained stable between $0.79 and $0.81 per month per square foot triple net (NNN). Countywide average asking rent was $0.79 as of 3Q12 which is 15% below the prerecession annual average and 10% below the 9-year average of $0.88 (Figure 10). The average monthly rent in Central County was $0.94, 25% higher than North County ($0.75) and 67% higher than South County ($0.56) as of 3Q12. While concessions have peaked in most submarkets, tenants still have an opportunity to take advantage of reduced concessions, with the exception of the prime buildings located in the prime submarkets where concessions
Fig. 10

Weighted Average Monthly Asking Rent (NNN) San Diego County Industrial, All Product Types excl. Sublease Fig. 10 Weighted Average Monthly Asking Rent (NNN)
San Diego County Industrial, All Product Types excl. Sublease

$1.10

$1.00 $0.94 $0.90

$0.98 $0.95 $0.89

$0.89
$0.80

$0.90

$0.81 $0.81 $0.79

$0.79

$0.70 9-Yr Avg. Monthly Asking Rent for All Product Types $0.88 Triple Net (NNN) PSF (2004 - 2012) $0.60 2004 2005 2006 2007 2008 2009 2010 2011 2012e 2013f

Source: Cassidy Turley Diego. Source: Cassidy Turley San San Diego. e) estimated; (f) forecasted by Cassidy Turley San Diego. e) estimated; (f) forecasted by Cassidy Turley San Diego.

Fig. 11

Top 10 Largest Industrial Landlords & Tenants in 2012
San Diego County All Product Types – Ranked by SF
Top 10 Tenants Rank Tenant 1 2 3 4 5 6 7 8 9 10 factory 2-U Life Technologies Corporation Price Self Storage Sharp HealthCare Hobie Cat Company Public Storage MOR Furniture For Less, Inc. Polaris Pool Systems, Inc. Sears Appliance Outlet Isis Pharmaceuticals, Inc. Top 10 Landlords Rank Landlord 1 2 3 4 5 6 7 8 9 10 H.G. Fenton Company Hamann Companies RREEF America LLC LBA Realty Alexandria Real Estate Equities, Inc. Goodrich Corporation General Atomics BioMed Realty L.P. Public Storage, Inc. Qualcomm Incorporated

Source: Cassidy Turley San Diego. 2012YTD as of 12/10/12.

29

have been reduced. The window of opportunity for tenants to secure the best/bargain deals in the best buildings is closing, a trend that is
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expected to strengthen in 2013. As supply of quality buildings continues to tighten, landlords

Fig. 12
Property San Diego Tech Center

Key Industrial Sales 2012YTD
SF 641,693 562,309 Seller/Buyer Charter Hall Office REIT / Beacon Capital Partners Collins Asset Management Group / Parallel Capital Partners Faraday Pointe CA LLC / Paragon Real Estate Investments Black Box Distribution / BLT Enterprises Price $152,500,000 Submarket Otay Mesa Otay Mesa

Sorrento Business Complex / One Technology Place Research Center Pointe Loker Corporate Center 9115 Activity Road

$53,390,779

119,561 123,454 85,180

$13,425,000

Vista Rancho Bernardo Scripps Ranch

$11,500,000

Miramar Activity Corporation / $10,171,600 KEIRE SDA, LLC

Source: Cassidy Turley San Diego. 2012YTD as of 3Q12.

of these buildings will be wellpositioned to lead the rent recovery in 2013 (Figure 10). Consequently, conditions for the landlords of the best assets located in prime submarkets will be much more favorable in 2013 than the conditions for landlords of older industrial buildings located in secondary submarkets. Many existing older buildings will need to increase efficiencies and retrofit new systems in order to compete effectively. Sales Activity: The total sales volume of Industrial countywide was $457.9M in 2012, a 12.7% increase compared to 2011.13 Industrial properties are increasingly attractive to investors due to improved leasing and lack of new supply. Top buyers in San Diego County in 2012 based on total sales volume were H.G. Fenton Company, Angelo, Gordon & Co.,

SR Commercial, Monica H Penner, Beacon Capital Partners, Providence Capital Group Inc., David and Yael Alpert, 2011 Elihu Family Trust, Steven M Muskal, Archie Kuehn (Figure 12). Top sellers were Collins Asset Management Group, Venture Corporation, Ryan Companies US, Inc. Average price per-square-foot was $99 in 2012 compared to $97 in 2011 and the average cap rate was 8.54% in 2012 compared to 7.61% in 2011 In 2013, the demand for “Class A” assets with well-positioned quality tenants in place in high-traffic submarkets will continue to outpace supply. The lack of available product will keep the lid on investment transaction volume instead of a lack of available capital. 2013 is shaping up to be all about
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gaining leasing momentum and strengthening market fundamentals as we move beyond the preelection “caution” and companies begin to focus on long-term facility solutions. A lack of new construction countywide will continue to play an important role in the San Diego industrial market recovery. Dynamic change will come to the market when mid-size and smaller companies, representing the majority of industrial tenants in San Diego, feel more confident about making real estate decisions.
1. 2013 Economic Outlook by Wells Fargo. December 13, 2012. 2. National University System Institute for Policy Research. 3. The Conference Board Leading Economic Index® (LEI), November 21, 2012. http://www.conference-board.org/ data/bcicountry.cfm?cid=1 4. U.S. Department of Commerce, December 13, 2012. http://www.census.gov/cgi-bin/briefroom/BriefRm 5. “The Secrets of Economic Indicators” by Bernard Baumohl. Wharton School Publishing. 2005. 6. http://www.ism.ws/ismreport/mfgrob.cfm 7. U.S. Department of Labor, Bureau of Labor Statistics Labor Dept. November 16, 2012. 8. www.bls.gov San Diego: October 2011 vs. October 2012. National: November 2011 vs. November 2012 9. Moody’s Analytics; economy.com; forecast last updated 9/20/2012. 10. Based on Cassidy Turley San Diego lease comparables total SF leased as of 12-6-2012 11. Cassidy Turley tracks industrial inventory that includes multi-tenant, single tenant and owner-occupied buildings over 10,000 SF, except in select submarkets where the competitive set requires the inclusion of smaller buildings. 12. Data as of 3Q12. 13. CoStar Group, Inc. and Real Capital Analytics, Inc.

30

San Diego Retail Forecast

31
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San Diego Retail Forecast
2013 Leasing Activity: Positive But Sluggish
The extent of improvements in the San Diego retail market in 2013 will depend heavily on improvements in the employment market and consumer spending, which accounts for 70% of all economic activity nationwide.1 Employed, confident and optimistic consumers are a must for the retail market recovery on both the national and local levels. The 2013 forecast remains cautious, considering the political and economic uncertainty including the concerns about the fiscal cliff’s impact on consumer spending. • Consumer Confidence: The good news is that based on recent economic data Americans are gaining faith in the recovery and are anticipating that the economy will continue to modestly expand throughout 2013.2 All three major indexes measuring consumer confidence reported an improvement in November: the benchmark Consumer Confidence Index, the Present Situation Index and the Expectations Index. “The Consumer Confidence Index
Fig. 1

Fig. 1

NetNet Change in in Jobs by Industry Sector Change Jobs Sector San Diego County, between Oct.by 2011 Industry & Oct. 2012
San Diego County, between Oct. 2011 & Oct. 2012
-4,000 -2,000 0 0 3,100 -1,900 -1,400 300 200 900 8,100 500 3,600 5,100 200 -600 Hotels Medical Office Industrial 5,400 Retail Office 2,000 4,000 6,000 8,000 10,000

Mining & Logging Construction Manufacturing Wholesale Retail Transp. & Wareh. & Util. Information Financial Activ. Prof. & Bus. Serv. Educ. Serv. Health Care Leisure & Hosp. Other Serv. Govt.

Between October 2011 and October 2012, total nonfarm employment increased by 23,500 jobs, or 1.9%. Professional
Between October 2011 and October 2012, total employment increased 23,500 8,100 jobs, or jobs. 1.9%. Professional and business services posted the and business services posted thenonfarm greatest year-over gain, by adding Administrative and support and waste greatest year-over(up gain,6,300) adding 8,100 jobs. Administrative andthan support and waste services 6,300) contributed to more than 75% of the job growth in this services contributed to more 75% of the job (up growth in this sector. Professional, scientific, and sector. Professional, scientific, and technical services added 1,700 jobs, followed by a gain of 100 jobs in management of companies and enterprises. Nine technical services added 1,700 jobs, followed by a gain of 100 jobs in management of companies and enterprises. other sectors also added jobs over the year. The notable came from leisure and hospitality (up 5,100); retail (up 5,400); educational and health services (up Nine other sectors also added jobs over the year. The notable came from leisure and hospitality (up 5,100); 4,100); and construction (up 3,100). Three industries reported year-over jobs losses: manufacturing (down 1,900), wholesale (1,400) and government (down 600). retail (up 5,400); educational and health services (up 4,100); and construction (up 3,100). Three industries Source: U.S. Department(down of Labor, 1,900), Bureau of Labor Statistics (1,400) Labor Dept.and government (down 600). reported year-over jobs losses: manufacturing wholesale

Source: U.S. Department of Labor, Bureau of Labor Statistics Labor Dept.

increased in November to 73.7 from 73.1 in October and is now at its highest level in more than four and a half years (76.4 Feb. 2008). Consumers have grown increasingly more upbeat about the current and expected state of the job market over the past few months, and this turnaround in sentiment is helping to boost confidence.”3 • Employment Forecast: San Diego’s employment market has improved notably over the last year, adding a
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33

total of 23,500 jobs of which 5,400 were in the retail sector outpacing the total annual job growth in neighboring Southern California metros between October 2011 and October 2012 (Figure 1 and 2).4 As a result, the unemployment rate in San Diego has dropped 1.2 percentage points to 8.6% over the last year compared to one percentage point decrease in the national unemployment rate.5 San Diego’s total employment is forecasted to increase 1.7%

Fig. 2

Net Net Change in in Jobs inin Southern Change Jobs SouthernCA CA
Fig. 2

Between Oct. 2011 & Oct. 2012 Between Oct. 2011 & Oct. 2012

other retail categories (Figures 6 and 13). Changing consumer behavior has forced retailers to grapple with more competitive and selective customer spending habits. All consumers want more for their money in addition to convenience and excellent service. An increased competition from online retailers should be added to the list of challenges of brick-and-mortar stores driven by consumers who crave the knowledge of price comparisons and the convenience of in-home shopping. Online shopping has had an especially profound impact on industries like book stores and movie rentals, forcing several retailers including Borders and Blockbuster to downsize and close stores in San Diego (Figure 13). To embrace rather than fight the growing online retail trade, more and more big name retailers, including Walmart, Best Buy, Home Depot, Sears and Walgreens, are adopting programs for online ordering and in-store pickup and returns.

60,000 50,000 40,000 1.5% 30,000 20,000 10,000 0 1.9% 23,500 57,800 1.5% 20,500 0.6% 7,300 San Diego Orange County Los Angeles Riverside & San Bernardino Counties

Between October 2011 and October 2012, nonfarm employment in San Diego increased by 23,500 jobs, or 1.9%. In Santa Ana-Anaheim-Irvine (Orange County), nonfarm employment increased by 20,500 jobs or 1.5%. In Riverside, total nonfarm employment increased by 7,300 jobs, or 0.6%. In Los Angeles, Between October increased 2011 and 2012, nonfarm employment in nonfarm San Diego increased by 23,500 jobs, or or 1.5% 1.9%. In Santa nonfarm employment by October 57,800 jobs, or 1.5%. In comparison, national employment increased by 1,949,000 and California’s Ana-Anaheim-Irvine (Orange County), nonfarm employment increased by 295,300 jobs,nonfarm or 2.1%. employment increased by 20,500 jobs or 1.5%. In Riverside, total nonfarm

employment increased by 7,300 jobs, or 0.6%. In Los Angeles, nonfarm employment increased by 57,800 jobs, or 1.5%. In Source: U.S. Department of Labor, Bureau of Labor Statistics Labor Dept. comparison, national nonfarm employment increased by 1,949,000 or 1.5% and California’s nonfarm employment increased Los Angeles* - Los Angeles-Long Beach-Glendale, CA. by 295,300 jobs, or 2.1%. Source: U.S. Department of Labor, Bureau of Labor Statistics Labor Dept. Los Angeles* - Los Angeles-Long Beach-Glendale, CA.

in 2013.6 All sectors except government, natural resources and mining are forecasted to add jobs in 2013 with growth rates ranging between 0.2% and 3.2%. Retail employment is forecasted to grow 1.5% in 2013 (Figure 3). The countywide unemployment rate is forecasted to continue the downward trend in 2013, positively affecting local retail sales(Figure 4). • Retail Tenants & Shopping Trends: Evaluating national sales – total

dollars spent – across all retail sectors, consumers are spending the most on their cars, food and beverages, general everyday merchandise and gas (Figure 5). Comparing the change in total dollars spent in 2012 to 2011, consumers are spending more on gas, non-store retailers (services), furniture, sporting goods and eating out. In San Diego, consumers favor fitness and health stores, sporting goods, pet supplies, drug stores and fast food restaurants among
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34

San Diego Retail Forecast
Fig. 3

Retail Jobs in San Diego, CA MSA
Fig. 3
Net Change in Jobs % Change

35

There is no doubt that the smaller mom-and-pop stores are the most vulnerable to e-commerce in this environment which has forced many smaller retailers to close their doors over the last three years in San Diego. Consequently, activity has increased among the franchisers who have a huge advantage over the mom-andpop stores, thanks in large part to a greater access to financing compared to individual smaller businesses. Many people from corporate America who have been laid off as well as entrepreneurs whose small stores did not survive the recession have chosen to convert to a franchise and take advantage of instant brand recognition and buying power, a trend that is expected to continue. Service-based franchises have proven to be the most successful as inventory is not required and, therefore, cannot be manipulated by the internet or outsourced for manufacturing. Massage Envy, a spa franchise, is one example in San Diego that has been very successful capturing market share over the last two years.

Retail Jobs in San Diego, CA MSA
Between 2007 and 2010 San Diego County lost a total of 17,620 retail jobs

8,000

6%
+ 6,820 + 4,842

4,000

4% 2% 0%

0
Between 1999 and 2006 San Diego County added a total of 23,267 retail jobs

(4,000)

-2% -4%

(8,000)

-6% -8%

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013f

2014f

San Diego-Carlsbad-San Marcos, CA Metropolitan Statistical Area (MSA). Retail Jobs include Retail Trade. San Diego-Carlsbad-San Marcos, CA Metropolitan Statistical Area (MSA). Jobs include Retail Trade. Source: Moody’s Analytics. (f) forecasted. Forecast lastRetail updated 9/20/2012.
Source: Moody’s Analytics. (f) forecasted. Forecast last updated 9/20/2012.

San Diego-Carlsbad-San Marcos, CA Metropolitan Statistical Area (MSA)
Taxable Sales Billions $16 Unemployment Rate 12% 11% 10% 9% 8% 7% 6%

Fig. 4 San Diego-Carlsbad-San Marcos, CA Metropolitan Statistical Area (MSA)

Fig. 4

Taxable Retail Sales vs. Unemployment Rate

Taxable Retail Sales vs. Unemployment Rate

$14
$12 $10 $8 $6 $4 $2 $0

1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

1Q13

3Q13

1Q14

3Q14

Source: Beacon Economics. Forecast last updated 10/1/2012. Source: Beacon Economics. Forecast last updated 10/1/2012.

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2015f

(12,000)

• Franchise Retail: Among other franchise serviceproviding retailers expanding in San Diego are haircut stores and full-service salon-type professionals. SportClips, providing haircuts for men in a sportsthemed environment, has signed 13 new leases in 2012 with high projections for 2013. Phenix Salon Suites, based out of Colorado Springs, provides upscale private suites functioning as fully-equipped minisalons and is currently franchised in 13 states. Phenix Salon Suites

currently has five open Southern California locations and plans on a strong expansion plan for 2013 with approximately 20-25 executed leases in 2013. On a national level, the company will have 35 locations open by the end of 2012 with over 100 under development. Supercuts has continued its San Diego expansion by opening three new stores in 2012 and has plans to open four more locations next year.

Fig. 5Fig.

U.S. Sales Retail FoodServices, Services, by Kind Kind of in $Millions U.S. Sales forfor Retail && Food ofBusiness Business in $Millions
Y/Y Change Furniture & home furn. stores Sporting goods, hobby, book & music stores Electronics & appliance stores Miscellaneous store retailers Clothing & clothing accessories stores Health & personal care stores Building material & garden eq. & supplies dealers Nonstore retailers Food services & drinking places Gasoline stations Food & beverage stores General merchandise stores Motor vehicle & parts dealers In $ Millions In $Millions $0 +5.3% +4.2% -5.6% +6.1% +5.5% -0.5% +0.7% +7.2% +4.2% +7.7% +3.9% +0.0% +5.0% $10,000 $20,000 $30,000 $40,000 $50,000 $60,000 $70,000

What are consumers nationwide? 5 What are consumers buying buying nationwide?

$7,938 $7,500 $8,150 Total U.S. Retail Sales $411.6 billion, up 3.8% Y/Y

$10,244
$20,077 $22,851 $24,318 $37,060 $44,028 $47,849 $53,776 $53,023 $74,777 $80,000

The advance estimates of U.S. retail and food services sales for October, 2012 adjusted for seasonal variation and holiday and trading-day differences, The advance estimates of U.S. retail and food services sales for October, 2012 adjusted for seasonal variation and holiday and but not for price changes, were $411.6 billion, 3.8% increase from a year ago (October, 2011). Total sales estimates are shown in millions of dollars and trading-day differences, but not for price changes, were $411.6 billion, 3.8% increase from a year ago (October, 2011). Total are based on data from the Advance Monthly Retail Trade Survey, Monthly Retail Trade Survey, and administrative records. sales estimates are shown in millions of dollars and are based on data from the Advance Monthly Retail Trade Survey, Monthly Retail Trade Survey, and administrative records. Source: U.S. Census Bureau Service Sector Statistics Division. November 14, 2012.
Source: U.S. Census Bureau Service Sector Statistics Division. November 14, 2012.

36

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San Diego Retail Forecast
Other expanding service-type franchises include European Wax Center and The Joint, the chiropractic place. Retail space is also being taken by service types that would traditionally find home in medical offices. Pacific Dental Services opened three new locations in San Diego in 2012 and three more locations are planned for next year. Medifast is also planning to expand in San Diego in 2013. In 2012, there was a surge of fitness studios including many franchised concepts such as The Bar Method, The Dailey Method, barre3 and Pure Barre expanding throughout Southern California. Fitness users, especially those with a discount model such as Chuze Fitness and Crunch Fitness, have been rapidly expanding in Southern California. • Restaurants: The restaurant segment, immune to the cannibalization of online shopping, served as another bright spot in 2012. Many of the fast, casual concepts that have been in expansion mode for the last
Fig. 6

Retail Tenant Categories in 2012
San Diego County
Downsizing Book Stores Movie Rentals Mid-Priced Grocery Stores Stationary & Gifts Stores Clothing Stores Furniture Home Goods Tanning Salons Shipping/Packing/Postal Mail Centers Finance/Consumer Loan Auto Dealerships Office Supplies
Source: Cassidy Turley San Diego.

New to Market/Expanding Wireless Discount Stores incl. Discount Grocery Stores Banks Fitness/Health/Personal Care Sporting Goods Pet Supplies Electronics/Games Fast Food Fast Casual Restaurants Paycheck Advance Drug Stores

37

few years continued the trend throughout 2012 and will continue in 2013. Luna Grill, which prides itself on healthy and fast Mediterranean cuisine, opened three new San Diego locations in 2012 and has plans to open three more locations in 2013. The popular San Francisco concept, Boudin SF, plans to open six locations in Southern California in 2013. Though San Diego seems to be reaching its saturation point with fast-casual burger concepts, 2012 welcomed new locations from Smashburger, The Counter, Five Guys and Burger Lounge. Pick Up
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Stix also opened two new locations in San Diego this year and has another two planned for next year. Boneheads: Grilled Fish & Piri Piri Chicken has plans to expand to San Diego with two new locations in 2013. • Grocery Stores: Besides serviceoriented retailers, grocery stores have benefited from the economic downturn as people dine out less frequently. Landlords have recognized the trend as groceryanchored centers have been successful in attracting traffic to their centers. People still have to

Fig. 7

San Diego County - All Center Types – Ranked by SF Leased - 2012YTD
Highest Leasing Activity in 2012 Rank Submarket 1 2 3 4 5 6 7 8 9 10 Encinitas Kearny Mesa El Cajon Downtown San Ysidro Escondido Oceanside San Marcos Miramar Chula Vista Highest Leasing Activity in 2011 Rank Submarket 1 2 3 4 5 6 7 8 9 10 Chula Vista Escondido National City Carlsbad Poway Downtown Oceanside El Cajon San Marcos Kearny Mesa

Top Retail Submarkets By Leasing Activity

Source: Cassidy Turley San Diego. 2012YTD as of 12/12/12.

benefits of increased sales in the future. Entertainment and events directly linked to driving sales are becoming increasingly common in stores and malls countywide. Stores will gear more towards service and the education of consumers about products. Expect to see more tastings, demos, free gifts and promotions to augment store traffic in 2013.To ensure success, retailers will need to continue to innovate in service and offerings to separate themselves from their competition and to capture sales. • Discount Stores: The recession pushed cash-strapped shoppers to pick necessities over discretionary items, allowing value-based retailers to gain market share and continue with their expansion plans in San Diego. The slow and shaky recovery is still steering users to remain conscious of the best use for each of their consumable dollars. Several value-based retailers have found opportunities in the excess space left by closed mid-to-bigbox retailers such as Mervyn’s, Circuit City, and Linens & Things. Landlords, on the other hand, are embracing the few segments that

buy food and other commodities regularly and consumers still want to go to the mall to see and be seen. Some grocery stores, such as Vons, Ralphs, and Fresh & Easy are attracting customers through community programs in San Diego such as giving a percentage of sales to local schools. Others, such as gas stations, banks and coffee shops, attract loyal customers through rewards programs. Many larger landlords are advertising their tenant promotions through social media in order to attract traffic.

Landlords are increasingly focusing on bringing daily needs and services into the centers, linking leisure activities with shopping and selecting the right mix of tenants. New and interesting tenants help a property stand out. For example, some landlords are adding child educational services that allow parents to drop off their kids and run errands in the immediate area.7 Landlords who cater to local demographics and provide an unforgettable shopping experience including outstanding customer service will reap the
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38

San Diego Retail Forecast
are experiencing growth to grapple with vacant space. Discount stores such as Dollar Tree, Family Dollar, and 99¢ Only continue to expand rapidly as consumers are favoring the discount model for many of their daily needs. 99¢ Only is even considering opening a store in the prestigious Beverly Hills area.8 The company opened one new store in San Diego in 2012 and is looking to add four more locations in the area in 2013. • Leasing: Evaluating retail leasing activity countywide for centers of all sizes in 2012,9 activity was 4% lower compared to last year; however the average tenant footprint countywide increased 76% from 3,253 SF in 2011 to 5,718 SF in 2012. Power centers recorded the highest increase in tenant footprints followed by showrooms, free-standing buildings and community centers. Tenant footprints decreased, however, in regional, urban retail and strip centers compared to 2011. The top five most sought-after submarkets in 2012 based on leases signed were Encinitas,
0.8 0.4 Millions 0.0

Fig. 8
Property

Key Retail Lease Transactions 2012YTD
SF Tenant Walmart LA Fitness Walmart Ross TJ Maxx Transaction Type Lease Lease Lease Lease Lease Submarket Encinitas Oceanside Downtown San Ysidro San Ysidro 75,360 45,800 27,500 24,500

The Plaza Encinitas Ranch 105,896 El Camino North 2121 E. Imperial Avenue The Plaza at The Border The Plaza at The Border

Source: Cassidy Turley San Diego. 2012YTD as of 11/30/12.

Fig. 9

San Diego Retail, All Center Types excl. Sublease San DiegoCounty County Retail, All Center Types excl. Sublease
Net Absorption Annual Completions

Fig. 9 Net Absorption Completions Net Absorption vs. vs. Completions

-0.4
-0.8 -1.2 -1.6

2007

2008

2009

2010

2011

2012e

2013f

Cassidy Turley San Diego tracks retail centers over 50,000 SF,up. excluding owner-user. and Uptown existing inventory totals include all retail totals include all retail centers 10,000 SF and Retail buildingsDowntown include community centers, freestanding retail, neighborcenters 10,000 SF and up. Retail buildings include community centers, freestanding retail, neighborhood centers, power centers, regional mall and strip hood centers, power centers, regional mall and strip centers. centers. Source: Cassidy Turley San Diego. (e) estimated, (f) forecasted.

Cassidy Turley San Diego tracks retail centers over 50,000 SF, excluding owner-user. Downtown and Uptown existing inventory

Source: Cassidy Turley San Diego. (e) estimated, (f) forecasted.

39

Kearny Mesa, El Cajon, Downtown and San Ysidro (Figures 7 and 8). These five submarkets combined accounted for 53% of the total
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square feet leased this year. The top 10 submarkets combined accounted for 79% of the total leasing activity, indicating that of

29 retail submarkets countywide, tenant demand is concentrated in the top 10. In 2011, leasing activity was spread across a wider range of submarkets as the top five submarkets combined accounted for 41% of the total space leased. Consequently, the top 10 submarkets combined accounted for 64% of the total leasing activity. • Net Absorption: Countywide net absorption for centers larger than 50,000 SF10 was 281,535 SF in the first half of 2012, which is double the amount absorbed during the second half of 2011. All center types recorded positive net absorption in the first half of 2012, with the exception of regional centers. In 2013, overall leasing activity level for centers of all sizes is expected to remain the same or improve slightly yet remain below the prerecession levels. Net absorption for centers 50,000 SF and larger is expected to be slightly weaker than in 2012 yet remain positive (Figure 9). The scarcity of prime retail space that

Fig. 10

San Diego County Retail, incl. Sublease
8% 7-Year Direct Vacancy Avg. 4.3% 6% 5.9%

San Diego County Retail, incl. Sublease

Fig. 10

Direct Vacancy Rate Direct Vacancy Rate

5.5%

5.5%

5.0%

4.8%

4%
3.1%

3.2%

2% 1.8%

0%

2006

2007

2008

2009

2010

2011

2012e

2013f

*Cassidy Turley San Diego tracks all retail centers over 50,000 SF, excluding owner-user. Downtown and Uptown existing inventory totals include all retail Cassidy Diego tracksinclude all retail centers over freestanding 50,000 SF, excluding owner-user. Downtown and Uptown existing centers 10,000 Turley SF and San up. Retail buildings community centers, retail, neighborhood centers, power centers, regional mall and strip inventory totals include all retail centers 10,000 SF and up. Retail buildings include community centers, freestanding retail, centers. Source: Cassidy Turley San Diego. (e) estimated, (f) forecasted. neighborhood centers, power centers, regional mall and strip centers.

Source: Cassidy Turley San Diego. (e) estimated, (f) forecasted.

meets all requirements of national tenants scouting the market will be one of the reasons of tempered activity. • Vacancy: Countywide direct vacancy is expected to decrease from 5.0% in 2012 to 4.8% in 2013 as the retail market continues to work its way through the recovery (Figure 10). With no new deliveries scheduled for 2013, leasing should remain competitive. This is especially true in well-positioned
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properties where demand is beginning to outpace supply and reduced rents will begin to creep back towards their pre-recessionary peak levels. Among submarkets commanding the highest effective rents include Del Mar, La Jolla, Solana Beach and UTC with effective rents ranging between $3.46 to $5.70 per month. The countywide effective rent average in 2012 was $2.37 compared to $2.39 in 2011. 40

San Diego Retail Forecast
• Asking Rents: The overall countywide monthly average asking rent for all center types was $1.99 per month per square foot triple net (NNN) in the first half of 2012, a 2.5% decrease from mid-year 2011. Free-standing, strip and power centers recorded the most improvements in asking rents from a year ago, a trend that is expected to continue. The countywide average asking rent for all center types is expected to increase between one and two percent in 2013. In most submarkets, tenants will continue to have the upper hand in negotiations. • Redevelopment Activity: Westfield Group is not only the largest landlord in San Diego but also a leader of redevelopment activity. The company owns seven shopping centers and employs approximately 13,000 people countywide (Figure 11). The highlights of three major revitalization projects in 2012 are: 1. Westfield University Towne Center (UTC): The impressive $180-million renovation and expansion included transformation of the entire
Property Balboa Mesa Shopping Center

Fig. 11

San Diego County All Product Types – Ranked by SF
Top 10 Landlords Rank Landlord 1 2 3 4 5 6 7 8 9 10 Westfield Group Sears Holdings Corporation Fashion Valley Mall, LLC Grossmont Shopping Center Co. Ecke Paul Ranch Utc Venture LLC Costco Wholesale Corporation Regency Centers LP Chula Vista Center LLC Nevada Investment Holdings Top 10 Tenants Rank Tenant 1 2 3 4 5 6 7 8 9 10 Nordstrom AMC Plaza Bonita 14 Lowe’s Walmart Sears Essentials Costco The Home Depot Neiman Marcus Regal Cinemas Kmart

Largest Retail Landlords & Tenants in 2012

Source: CoStar. 2012 as of 11/30/12.

Fig. 12

Key Retail Sale Transactions 2012YTD
SF 189,321 Seller/Buyer Lubert-Adler Partners, L.P. / Regency Centers Corporation Price $59,500,000 Submarket Clairemont

Bonita Centre

99,701

Nottingham Associates Inc. / Donahue $30,550,000 Schriber Commercial Real Estate Essel Enterprises / Kleege Enterprises Excel Trust, Inc. / Excel Trust, Inc. & GEM Realty Capital, Inc. Sea Breeze Old Grove, LLC / Gerrity Group $27,300,000 $23,500,000 $19,550,000

Chula Vista

Clairemont Village La Costa Towne Center Old Grove Marketplace

127,148 121,429 81,279

Clairemont Carlsbad Oceanside

Source: Cassidy Turley San Diego. 2012YTD as of 11/30/12.

41

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center site into a retail-resort inspired experience, including alfresco dining, new A-list retailers and entertainment - all inviting shoppers to “Escape... Everyday.” A number of new retailers including Splendid, Eureka!, Tesla Motors, Seasons 52 and ArcLight have chosen Westfield UTC as their first location in the San Diego market, joining other popular new arrivals such as Tiffany & Co., J. Crew, Tender Greens and Elixir. This project, which exemplifies Westfield’s ongoing commitment to San Diego, generated approximately 2,400 new jobs in San Diego, including nearly 1,000 construction jobs. The center meets LEED Gold certification standards. The UTC community, city officials and special guests celebrated the Grand Opening on November 15, 2012.11 2. Westfield North County: The ambitious and longoverdue $55-million redevelopment and revitalization of the 83-acre, 26-year-old mall located in Escondido started on April 3, 2012.12 This project was among the five largest retail construction projects to break ground in the nation during the first half of 2012.13 This project will not only transform the shopping center to attract new retailers and offer patrons an enhanced shopping experience with a greater diversity of stores, dining opportunities and services but accounts for an estimated 318 new construction jobs and 551 permanent service and retail positions. Upon completion in December 2012, the improvements will bring an estimated additional $1 million in sales tax reaching $5 million in lease revenues to the City of Escondido annually. Additional

revenues will be generated by attracting new retail opportunities and services not previously found in the market and through increased sales at the center.14 The highlights of the revitalization include15: ◦◦ A new 150,000-square-foot, multi-level Target established in the space formerly occupied by Robinsons-May will bring new life to a former department store building that has been vacant since 2006. ◦◦ Revitalization of the interior of the shopping center, which includes new floor finishes, interior paint and lighting schemes, furniture, handrails, signage, and a children’s play area. ◦◦ New full-service restaurants. ◦◦ Renovating the dining court and restrooms. ◦◦ Remodeling and updating all eight entrances to the center. ◦◦ Resurfacing the entire parking lot. 3. The Westfield Horton Plaza: Originally built in 1870, this Plaza is on its way to becoming San Diego’s version of Times Square.16 Westfield sold the department store site back to the city in exchange for dropping a profit-sharing agreement that yields about $2 million annually to the city. The $14.7 million expansion started in November 2012 and is planned to be completed by March 2014. Construction plans include demolishing the old Robinson’s-May and Planet Hollywood building to make room for a new 1.3-acre public park that includes the existing park and will extend south to Balboa Theater, Fourth

42

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San Diego Retail Forecast
Avenue and E Street.17 The space will be utilized by the city to create an outdoor venue capable of hosting over 200 events a year to cater to 37,000 residents18 of Downtown San Diego as well as visitors. • Sales Activity: The total sales volume of retail centers of all sizes countywide was $399.6 million in 2012, a 30.4% decrease compared to 2011. Top buyers in San Diego County in 2012 based on total sales volume were Jason Zana, Kimco Realty Corporation, Donahue Schriber Commercial Real Estate, Excel Trust, Inc., Laurent Hamon, Retail Opportunity Investments Corp., J4 Asset Management, Inc., Gerrity Group LLC, Rosecrans Plaza Kiffmann, LLC, and Saber SMCCP LLC (Figure 12). Top sellers were LNR Partners, Inc., C.W. Clark, Inc., and BlackRock, Inc. The average price per-square-foot was $254 in 2012 compared to $216 in 2011. The average cap rate was 6.90% in 2012 compared to 7.09% in 2011.19 In 2013, the demand for Class A assets with well-positioned quality tenants in high-traffic submarkets will continue to outpace supply. The lack of available product will keep the lid on transaction volume instead of a lack of available capital. Overall, 2013 is slated to lay the groundwork for the San Diego retail market to transition from the slow recovery seen since the last recession, including the financial crisis, to a more vibrant recovery in the coming years. San Diego remains an attractive destination for retail companies with its high median income and positive population growth. Retailers will continue to compete for the most visible locations, especially with a dearth of new construction projects on the horizon. Landlords with less desirable locations will attempt to attract and retain quality tenants by investing in the revitalization of their properties or offering concessions. The vibrancy of San Diego’s retail sector was greatly hurt by the recession, but
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fundamentals are showing signs of recovery.
1. “The Secrets of Economic Indicators” by Bernard Baumohl. Wharton School Publishing. 2005. 2. The Conference Board Leading Economic Index® (LEI), November 21, 2012. http://www. conference-board.org/data/bcicountry.cfm?cid=1 3. The Conference Board, November 27, 2012. http://www.conference-board.org/data/consumerconfidence.cfm 4. U.S. Department of Labor, Bureau of Labor Statistics Labor Dept. November 16, 2012. 5. www.bls.gov San Diego: October 2011 vs. October 2012. National: November 2011 vs. November 2012 6. Moody’s Analytics; economy.com; forecast last updated 9/20/2012. 7. Shopping Centers Today, December 2012. 8. http://articles.latimes.com/2012/oct/12/business/la-fi-99cents-rodeo-drive-20121012¬ 9. Based on lease comparables total SF leased as of 12-12-2012 10. Cassidy Turley San Diego tracks retail centers over 50,000 SF, excluding owner-user. Downtown and Uptown existing inventory totals include all retail centers 10,000 SF and up. Retail buildings include community centers, freestanding retail, neighborhood centers, power centers, regional mall and strip centers. 11. http://www.westfield.com/corporate/news-announcements/media-releases/2012/20121116_14704.html 12. http://www.nctimes.com/news/local/escondido/escondido-westfield-breaks-ground-on-mmall-upgrade/article_73f782b1-7df8-54d7-a8a9-016d03325572.html 13. http://www.nctimes.com/news/local/escondido/escondido-mall-renovations-among-top-fiveretail-projects-in-nation/article_a674fcc9-bca5-5316-9666-8dd211fed917.html 14. http://www.westfield.com/northcounty/news-and-events/revitalize/ 15. http://www.nctimes.com/news/local/escondido/escondido-westfield-breaks-ground-on-mmall-upgrade/article_73f782b1-7df8-54d7-a8a9-016d03325572.html 16. San Diego Daily Transcript, November 29, 2012. http://www.sddt.com/reports/article.cfm?RID =961&SourceCode=20121129czf&_t=Horton+Plaza+project+groundbreaking+held 17. Union Tribune, November 27, 2012 “Horton Plaza expansion to begin with boom” by Roger Showley 18. SANDAG. 19. CoStar Group, Inc. and Real Capital Analytics, Inc.

43

Fig. 13

2012 Retail Store Closings & Openings
2012 Retail Store Openings: U.S. Retailers Expanding Nationwide
# of Stores Opened highlighted in PURPLE - stores opening in San Diego Nationwide 630 500 280 198 175 170 145 140 135 125 100 85 80 75 75 75 75 60 53 50 50 50 50 47 45 40 38 40 30 28 25 25 25 25 25 24 22 21 20 18 15 15 15 15 15 15 15 11 11 10 10 7-Eleven Family Dollar Dunkin Donuts Walgreens McDonald's O'Reilly Auto Parts Ascena Retail (Dressbarn, Marices, Justice) Advance Auto Parts Wal-Mart Supercenter Charming Shoppes Walmart Fossil Big Lots Foundry Big & Tall Supply Company ( JC Penney) Francesca's Collections Pep Boys Rue 21 Ulta Fastenal AutoZone Citi Trends Five Below Versone Accessories (Cato) IQuikTrip Dots Body Central Steele's Casual Male Shoe Carnival 99 Cents Only Crocs Express Krispy Kreme Target Texas Roadhouse Microsoft Wetseal Chico's Tilly's Fresh & Easy Anthropologie Athleta Cato Charming Charlie's H&M JB Hi-Fi Nordstrom Rack Bebe Free People Costco David's Bridal
About.com Retail Industry. List last updated 7/18/12.

2012 Retail Store Closings: U.S. Retailers Downsizing or Going Out of Business Nationwide
# of Stores Closed Nationwide 600 500 180 172 137 123 120 113 103 100 100 96 93 76 70 63 60 55 50 50 40 35 30 25 25 25 22 19 14 13 12 11 8 6 6 5 5 5 5 4 4 3 3 3 3 3 2 2 2 2 2 highlighted in PURPLE - stores closing in San Diego Fashion Bug Blockbuster Abercrombie & Fitch Sears Ritz Camera & Image/Wolf Camera Collective Brands (Payless, Stride Rite) Pacific Sunwear Food Lion Christopher & Banks Family Dollar The Gap Avenue Esprit USA Drug/Super D/ Drug Warehouse/May's/Med-X Casual MaleXL Betsey Johnson SuperValu (Albertson's/ACME/Save-A-Lot) Ascena Retail (Dressbarn, Marices, Justice) Best Buy T.J. Maxx Catherine's Office Max Coldwater Creek Beauty 360 Lane Bryant Sonic 77kids Daffy's United Carpets Cato Fred's Sara Lee Outlets Bill's BBQ Bottom Dollar Waldbaums Carl's Patio Hallmark Pathmark Shoe Carnival Macaroni Grill Mandee A&P Bloom Genuardi Loupot's Wise Buys All Sports C&C Kids CVS Disney Store O' Boys Bar-B-Q
About.com Retail Industry. List last updated 9/18/12.

44

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San Diego Investment Forecast

45
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San Diego Investment Forecast
Fig. 1

Pursuit of Trophy Assets Continues
Throughout 2012 the San Diego commercial real estate investment market transaction volume fell back to 2010 level, reporting a 19% year-over-year decrease compared to 2011.1 The sluggish economic recovery, Presidential elections, Europe’s financial difficulties, uncertainty about the fiscal cliff and sequestration, combined with the diminishing supply of available trophy assets were among the key factors that kept the national and local commercial real estate investment market at a slow pace in 2012. The political uncertainty that was expected to cease after the November 2012 elections has continued due to fiscal cliff issues and will carry over into 2013, tempering investment activity. With changed tax codes such as the increase in capital gains tax and a 3.8% surtax on investment income to fund the new healthcare law, investors will presumably be reluctant to partake in any substantial transaction early in 2013. 47

Interest Rate – U.S. Economic Forecast
Fig. 1
3 Month LIBOR Prime Rate 5 Year Note 10 Year Note

Interest Rates (U.S. Economic Forecast)
30 Year Bond

5%

4%
3.25%

3%
2.82%

2%

1.65%

1%

0.62% 0.36%

0%

1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14
Source: Wells Fargo U.S. Economic Forecast. Release Date: December 13, 2012
Source: Wells Fargo U.S. Economic Forecast. Release Date: December 13, 2012

Fortunately, the longer the economic and political environments remain uncertain, the more attractive and logical commercial real estate will look as an investment. Demand for income-producing properties is expected to continue to grow, supported by improving fundamentals across all property types and the Fed’s accommodative monetary policy. The most sought after properties are stabilized, Class A trophy assets located in the major metro markets with long-term leases in place and

potential for increased cash flow. These markets are perceived to be the most resilient and successful investment options and will continue to be investors’ favorite markets for the foreseeable future (Figure 2). However, investment activity in major markets has been losing momentum due to the limited number of Class A trophy properties available for acquisition. Furthermore, investors have pushed the prices for the best properties to premium levels – activity fueled by increased debt availability to those who qualify – resulting in a very competitive market dominated

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Fig. 2

Rankings by Total Year-to-Date Sales
Rankings
09YTD 10YTD 11YTD12YTD

Fig. 2

Rankings by Total Year-to-Date Sales
Office, Industrial, Retail, Mulifamily

Market

2012YTD Sales Volume
$15.44B $12.34B $10.18B $6.00B $5.71B

*2012 YTD % Change
$21.56B -9% 34% 34% 5% -9% 21% 14% 69% 11% 26% 32% 5% 67% 168% 61% 94% 46% -32% 11% 86% 35%

Major Primary Secondary

1 2 4 3 5 6 7 14 9 12 10 8 13 23 11 20 28 19 18 24 17 16 21 25 30 22 15 29 26 27

1 3 4 2 8 6 7 10 9 5 13 12 16 14 11 18 26 25 22 23 15 17 20 24 30 29 21 27 19 28

1 2 4 3 5 6 7 12 8 10 11 9 14 20 15 21 19 13 18 26 24 17 22 29 28 16 25 30 23 27

1 NYC Metro LA Metro 2 SF Metro 3 DC Metro 4 Chicago 5 Dallas 6 Houston 7 Seattle 8 Boston 9 So Fla 10 Phoenix 11 Atlanta 12 Denver 13 Austin 14 15 San Diego Baltimore 16 Charlotte 17 Philly Metro 18 19 Minneapolis Nashville 20 Orlando 21 Tampa 22 Portland 23 Detroit 24 Memphis 25 26 Las Vegas 27 Sacramento Cleveland 28 St Louis 29 Cincinnati 30

$5.30B
$5.29B $4.97B $4.42B $4.26B $4.17B $3.59B $3.13B $2.98B $2.09B $1.79B

$1.67B
$1.51B $1.31B $1.28B $1.21B $1.04B $795M $730M $682M $670M $609M

-14%
7% 54% 22% -58%

-15%
73% -48% -23%

$502M
$497M

YTD represents 1Q-3Q of given year. *2012 YTD % Change represents change between 2012YTD and 2011YTD. Source: Real Capital Analytics. Based on properties & portfolios $5 million or greater.
YTD represents 1Q-3Q of given year. *2012 YTD % Change represents change between 2012YTD and 2011YTD. Source: Real Capital Analytics. Based on properties & portfolios $5 million or greater.

48
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San Diego Investment Forecast
by large institutional investors and ultra-wealthy private investors with pristine credit and deep pockets. That has resulted not only in a highly competitive environment but also in a decrease in capitalization (cap) rates and therefore lower yields (Figures 5 and 6). The good news is that bidding wars in major markets are driving investors and therefore transaction volume beyond traditional hot spots to primary and secondary markets such as San Diego. The more investors shift focus outside the major markets in search of a steady cash flow, the more competitive the search for a great deal or a “diamond in the rough” property will become. The challenge investors will continue to face, however, will be finding and closing lucrative deals as competition heats up for a shrinking pool of properties.
Fig. 4
Property San Diego Tech Center DiamondView Tower Legacy Apartment Homes Balboa Mesa Shopping Center SF 641,693 305,255 351,336 189,321 120,350

In 2013, activity in the San Diego investment market is expected to improve moderately. Total sales
Fig. 3

volumes in San Diego for all property types combined has increased since 2009 with the exception of

Fig. 3 San Diego Market: All Commercial (Office-Industrial-Retail)

Who is Buying in San Diego?
Who is Buying in San Diego?
United States San Diego
14% 7% 28% 38%
Institutional

San Diego Market: All Commercial (Office-Industrial-Retail)

23%

29%

32%

35%

10%

4% 11%

25%

Cross-Border Public Listed/REITs Private User/Other

20%

13%

25%

29%

35% 29%

33%

20% 2009

15% 2010

11% 2011

4% 2012 (YTD)

8% 2012 (YTD)

Source: Real Capital Analytics – 2012YTD 11/9/12. Source: Real Capital Analytics – 2012YTD asas of of 11/9/12. Based properties & portfolios $5 millionand andgreater. greater. Based on on properties & portfolios $5 million

Key Sale Transactions 2012YTD
Price $152,500,000 $120,880,980 $91,000,000 $59,500,000 $34,100,000 Submarket Sorrento Mesa Downtown Mira Mesa Clairemont Sorrento Mesa Property Type Industrial Office Multi-Family Retail Office

Seller/Buyer Charter Hall Office REIT / Beacon Capital Partners Wereldhave USA-CA LLC/ Cruzan | Monroe/ & CIGNA Garden Communities LLC/ R&V Management Corporation Lubert-Adler Partners, L.P. / Regency Centers Corporation RREEF America LLC/ BCL/ AEW Capital Management, L.P.

49

One Pacific Heights

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Fig. 5

2012, largely due to a lack of product that matches investor requirements (Figure 7). Office sales led the way in 2012 followed by multi-family, industrial and retail properties (Figure 8). The most active buyers of San Diego properties in 2012 were institutional, private, and crossborder investors, a trend that is expected to continue in 2013 (Figure 3). In 2013, total sales volume is forecasted to increase between 20% and 30%, encompassing all product types fueled by improving market fundamentals such as decreasing vacancies, low cost of capital, and investor willingness to take a little more risk in search for higher yields outside the highly competitive Class A trophy assets markets. However, the lack of existing product and new construction may impede the ultimate San Diego transaction potential. San Diego Sales by Product Type

Average Property Index Returns By Property Type

Fig. 5
12% 8% 4%

Average Property Index Returns By Property Type
Office Industrial Retail Multifamily

0%
-4% -8% -12%

3Q00

3Q01

3Q02

3Q03

3Q04

3Q05

3Q06

3Q07

3Q08

3Q09

3Q10

3Q11

3Q12

Source: National Council of Real Estate Investment Fiduciaries (NCREIF). http://www.ncreif.org/property-index-returns.aspx?region=W
Source: National Council of Real Estate Investment Fiduciaries (NCREIF). http://www.ncreif.org/property-index-returns.aspx?region=W

Fig 6

Average Cap Rates in San Diego Market
Fig. 6
Office Industrial Retail

Average Cap Rates in San Diego Market
Multi-Family

10% 9% 8% 7% 6% 5% 4% 3% 5.8% 8.1% 7.8% 6.5%

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011 2012YTD

Source: Real Capital Analytics – 2012YTD as of 12/10/12. Based on properties &Analytics portfolios $5 million and greater. Source: Real Capital – 2012YTD as of 12/10/12.

• Office: The office market in San Diego was stalled from its growth

Based on properties & portfolios $5 million and greater.

50
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San Diego Investment Forecast
Total Sales Transaction Volume in San Diego Fig. 7 Total Sales Transaction Volume in San Diego
Fig. 7

Annual Sales Transaction Volume
Fig. 8

Sales by Property Type in San Diego 2012YTD Fig. 8 Sales by Property Type in San Diego 2012YTD
Total Sales Volume in $ Billions $1.6 $1.7 $1.9

$12 $10

Office

Industrial

*Retail

*Multi-Family

Forecast

$4.6 billion average annual sales volume from 2002 to 2011 (10 years)
Time period 2010YTD (1Q10-3Q10) 2011YTD (1Q11-3Q11) 2012YTD (1Q12-3Q12)

$1.4

Billions

$8 $6 $4
$1.1 $1.2 $2.6 $2.1 $0.5 $1.5

$0.9

*Retail 18%

% Change 121.8% 9.1% 6.2%

$1.5

Office 31%

*Excludes entity level, partial interest transfers & pending

$1.0 $1.1 $0.7 $0.6 $2.2 $1.3

$1.1

Industrial 25%
$5.6 $1.0 $0.8 $0.7 $0.4 $0.3 $0.1 $0.2 $0.5 $0.5 $0.8 $1.3 $0.6 $0.5 $0.5 $0.4 $0.5 $1.0 $1.4 $0.7 $0.5 $0.6

$1.4 $3.6 $2.2

$2 $0

$1.4 $0.3 $0.3 $1.1

$0.2 $0.4
$1.1

*Multi-Family 26%

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011 2012e 2013f

Fig. 9

Office Sales Transaction Volume in San Diego Fig. 9 Office Sales Transaction Volume in San Diego
Source: Real Capital Analytics 2002 – 2012YTD as of 12/20/12. Based on properties & portfolios $5 million and greater. *Excludes entity level, partial interest transfers, & pending transactions. (e) estimated, (f) forecasted by Cassidy Turley San Diego.

Fig. 10

Fig. 10
$2,000

Industrial Sales Transaction Volume in San Diego

Industrial Sales Transaction Volume in San Diego
*Excludes entity level, partial interest transfers, & pending transactions.

Source: Real Capital Analytics – 2012YTD represents 1Q12-3Q12 as of 12/20/12. Based on properties & portfolios $5 million and greater.

$6,000

$5,000

Millions

$2.0 Billion avg. annual office sales volume from 2002 to 2011 or 10 years

$817.1 million avg. annual industrial sales volume from 2002 to 2011 or 10 years $1,600

$4,000

Millions

$1,200

$3,000
$800

$2,000
$400

$1,000
$1,091.6 $1,283.3 $2,194.0 $2,158.3 $3,644.1 $5,562.9 $1,086.0 $459.9 $817.6 $1,282.3 $1,148.3 $1,414.7

$0

$0

$319.3

$633.6

$1,141.5 $1,376.8 $1,509.2 $1,531.0

$408.4

$215.9

$538.1

$497.7

$564.4

$581.0

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012e 2013f

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011 2012e 2013f

Fig. 11

Retail Sales Transaction Volume in San Diego
Source: Real Capital Analytics 2002 – 2012YTD as of 12/20/12. Based on properties & portfolios $5 million and greater. (e) estimated, (f) forecasted by Cassidy Turley San Diego.

Fig. 12

Fig. 11

Retail Sales Transaction Volume in San Diego
$569 million avg. annual retail sales volume from 2002 to 2011 or 10 years

Based on properties & portfolios $5 million and greater. Multi-Family Sales Transaction Volume in San Diego (e) estimated, (f) forecasted by Cassidy Turley San Diego. Source: Real Capital Analytics 2002 – 2012YTD as of 12/20/12.

Fig. 12
$3,000

Multi-Family Sales Transaction Volume in San Diego
$1.3 Billion avg. annual multi-family sales volume from 2002 to 2011 or 10 years

$1,600

Millions

$1,400 $1,200

$2,500

$2,000

Millions

$1,000 $800 $600 $400

$1,500

$1,000

$500

$200

$0

$322.6

$725.7

$963.0

$1,083.1

$506.4

$864.5

$186.0

$109.3

$424.2

$632.6

$450.0

$495.6

$0

1,391.8

1,099.4

2,587.9

2,121.5

1,176.7

1,375.7

787.9

349.4

676.3

1,014.6

$608.40

$638.8

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011 2012e 2013f

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011 2012e 2013f

51

Source: Real Capital Analytics 2002 – 2012YTD as of 12/20/12. (e) estimated, (f) forecasted Based on properties & portfolios $5 million and greater excluding entity level, partial interest transfers, & pending transactions. (e) estimated, (f) forecasted by Cassidy Turley San Diego.

Source: Real Capital Analytics 2002 – 2012YTD as of 12/6/12. Based on properties & portfolios $5 million and greater. Source: Real Capital Analytics 2002 – 2012YTD as of 12/20/12. by Cassidy Turley San Based on Diego. properties & portfolios $5 million and greater excluding entity level, partial interest transfers, & pending transactions.
(e) estimated, (f) forecasted by Cassidy Turley San Diego.

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trend in 2012 with an estimated decrease in transaction volume of 10.5% from 2011. Looking into 2013, demand for Class A assets with well-positioned quality tenants in place will continue to outpace supply. The lack of available product will hinder sales volume momentum. However, as investors set their eyes on riskier tangible assets with higher yield potential, office sales are anticipated to pick up and increase by 23.2% next year (Figure 9).

bounce back in 2013 with growth forecasted at 10.1% (Figure 11). Triple net investments and shopping centers with groceryanchored tenants will feed the majority of investor appetite. • Multi-Family: For the first time since emerging from the recession, multi-family sales in San Diego witnessed a decline in transaction volume from the previous year due to the shortage of supply and landlords being less motivated to sell as market fundamentals continued to strengthen. The total sales volume for multi-family properties of all sizes countywide was $608.4 million in 2012, a 40.0% decrease compared to 2011 (Figure 12). However, with

many large transactions currently in the pipeline such as the pending Archstone portfolio reorganization, sales are expected to regain momentum and increase by approximately 5.0% in 2013. Debt Market: Overall, debt markets keep improving with historically low interest rates and greater liquidity of capital. CMBS lenders are steadily climbing back with their expected issuance of debt to rise by $10 billion in 2013. Life company lending persists but only accounts for 12% of total issuance and cannot completely fill the void that the CMBS market once dominated during its peak in 2007. Commercial banks represent 34% of issuance but even with demand for commercial real estate

• Industrial: With leasing activity improving and a lack of new supply, industrial properties have become increasingly more attractive to investors. As a result, San Diego witnessed a slight uptick in sales activity in this sector. In 2012, Fig. 13 Total Fig. Outstanding DistressDistress in the U.S. 13 Total Outstanding in the total industrial sales volume countywide is estimated to reach Troubled REO Restructured Resolved $564.4 million, a 13.4% increase $400 compared to 2011. Sales volume of industrial properties has been $300 steady for the last three years, averaging $533.4 million per year. Given the aforementioned trend, $200 industrial sales are projected to continue to edge up slightly by the $100 end of 2013 (Figure 10).
Billions

U.S.

• Retail: Due to the lack of quality product, annual sales fell 28.9% from $632.6 million in 2011 to an estimated $450.0 million in 2012. Retail sales are poised to

Jan-10

Jan-08

Jan-09

Jan-11

May-08

May-09

May-10

May-11

Jan-12

May-12

Sep-08

Sep-09

Sep-10

Sep-11

Source: Real Capital Analytics – 11/12/2012. Based on properties & portfolios $5 million and greater.
Source: Real Capital Analytics – 11/12/2012. Based on properties & portfolios $5 million and greater.

Sep-12

$0

52

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San Diego Investment Forecast
loans, they are not increasing overall loan volume.2 Underwriting is very disciplined and focused, scrutinizing asset quality, location, and historical asset and market strength more than ever before. There has been a persistent demand for loans to buy commercial real estate and there is a tremendous appetite for high-quality assets. Competition is fierce for top-quality product with commercial banks competing amongst each other as well as life insurance companies and the growing CMBS market; this, in turn, is driving interest rates down. However, investors who want to buy a riskier property (A- or below) are still having trouble obtaining financing with reasonable terms. Distressed Market: Distressed product, while still a major component of the investment market, has declined by 6% in 2012. Workouts have exceeded inflows with the majority of inflows resulting from maturity defaults of remaining underperforming CMBS loans. In total, from the recession until present, $374.4 billion of significant property has become distressed and 55% of the total has been resolved.3
Fig. 14

Fig. 14

Current Known Distress through Current Known Distress through 10/24/2012 10/24/2012 Select West Region Markets
Select West Region Markets
Industrial Retail Office Apartment

Los Angeles Las Vegas Inland Empire Orange Co Seattle East Bay Sacramento San Diego San Francisco San Jose Portland $0 $1,000 $2,000 $3,000 $4,000 $5,000
Office Industrial Retail Multi-Family

Total Distress in San Diego in $ Millions San Diego Distress as a % of Total West Region Distress Total West Region Distress in $ Millions

$680.0 6.2% $10,887.4

$168.6 3.9%

$255.6 3.7%

$61.4 1.1% $5,554.0

$4,356.2 $6,941.1

Millions $6,000 $7,000

Source: Real Capital Analytics – 11/12/2012. Based on properties & portfolios $5 million and greater.
Source: Real Capital Analytics – 11/12/2012. Based on properties & portfolios $5 million and greater.

However, even considering the shrinking number of distressed assets paired with a growing percentage of workouts, there is still the $1.5 trillion worth of commercial loans that will mature between now and 2017. This represents greater uncertainty and may keep the market from a full recovery. With CMBS as the largest chunk of this remaining total, and its default rate currently at 10%, full recovery is highly unlikely in the immediate future unless values can grow and keep increasing at a very high rate (Figure 13). San Diego has relatively few
Cassidy Turley San Diego | www.CassidyTurley.com/SanDiego

distressed assets; however there still remains a good number of overleveraged owners hoping for values to continue to increase. With $27.8 billion of current distressed office, industrial, retail, and multifamily assets combined in the Western region, San Diego ranks as one of the lowest distressed markets with $1.2 billion or roughly 4.2% of the total distress in the Western region (Figure 14). In 2013, the San Diego investment market is expected to continue to parallel the US economy by showing growth, but at a moderate pace.

53

The lasting sluggish real estate recovery should continue at the same pace in 2013 due to lingering uncertainty about market specific and macroeconomic factors. The U.S. deficit, the pending Euro crisis, a crippled credit market, and ramifications of the fiscal cliff especially tax increases and Federal spending cuts - will all hinder full investment potential. The flow of institutional and wealthy private investor capital into the secondary markets along with the low interest rate environment and a subtle climb in prices and rents will fuel the San Diego market throughout 2013. The determining factor will be the availability of preferred product and its ability to propagate to match investor demand. As for the debt market, life insurance companies will maintain their current supply while selectively competing for top deals. Commercial banks will preserve the majority of assets and CMBS will continue its resurgence as it competes for more transactions. Commercial real estate fundamentals will persist combined with a rising supply of debt and favorable interest rates through 2013.
1. Real Capital Analytics, Inc., based on sales of properties and portfolios $5 million and greater.

2. Federal Reserve, The July 2012 Senior Loan Officer Opinion Survey on Bank Lending Practices, July 2012 3. Real Capital Analytics, Mid-year Review 2012 Distress Update

54
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San Diego Multi-Family Forecast

55
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San Diego Multi-Family Forecast
The First to Fully Recover & Begin Expansion
The San Diego multi-family market has continued to act as a beacon of hope for the larger regional commercial real estate market, becoming the first sector to make a full transition from the recovery phase into expansion mode. 2012 was met with tight vacancy rates and an influx of new national landlords entering the investment arena. Despite an uptick in new construction and development, the outlook for San Diego’s multi-family market in 2013
Fig. 1

should remain defined by high occupancy and modest rent growth as demand for rental residencies continues to outplace supply. Investment Activity: For the first time since the bottom of the recession, multi-family sales activity in San Diego witnessed a decline in yearover-year transaction volume, not due to a lack of investor interest but to the shortage of supply with landlords less motivated to sell. The total sales volume for multi-family properties of all sizes countywide was $904.1 million in 2012, a 27.9%

decrease compared to 2011.1 Top buyers in San Diego County in 2012 based on total sales volume were R&V Management Corp. accounting for 12.7% of all sales transacted followed by JH Real Estate Partners (7.3%) and Greystar RE Partners (7.2%) (Figure 1 and 3). Among the top sellers were Garden Communities SW, R&V Management Corp., and BlackRock. As the primary markets such as New York and San Francisco continue to lack supply and experience fierce competition among buyers, it is clear that private equity funds and institutional investors are

Multi-Family Buyers & Sellers in 2012
San Diego County
Top 10 Sellers Acquisitions (in millions) $115.1 $66.0 $64.9 $23.0 $20.1 $20.1 $19.7 $16.5 $15.3 $14.7 Rank Buyer 1 2 3 4 5 6 7 8 9 10 Garden Communities SW R&V Management Corp BlackRock Essex Property Trust Davlyn Investments Inc Steadfast Companies Genton Property Group Efren R Cota Trust BRE Properties WLA Investments Seller Type Private Private Institutional Public Private Private Private Private Public Private Dispositions (in millions) $91.0 $89.5 $64.9 $28.3 $24.1 $23.3 $19.7 $17.5 $12.6 $8.0

Top 10 Buyers Rank Buyer 1 2 3 4 5 6 7 8 9 10 R&V Management Corp JH Real Estate Partners Greystar RE Partners Standard Property Co Triumph Management Co Conrad Prebys AIMCO Dornin Investment Group Highland Property Advisors Efren R Cota Trust Buyer Type Private Private Private Private Private Private Public Private Private Private

57

Rankings based on the amount of acquisitions/dispositions. Source: CoStar; Real Capital Analytics.

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Fig. 2

Multi-Family Sales Volume in San Diego County

finding the secondary markets such as San Diego a more attractive place to invest. Smaller apartment complexes, defined as those with less than 100 rentable units, have seen strong sales and contributed to more than half of the total volume of transactions. Larger communities with over 100 units witnessed a decline in investment activity compared to 2011 (Figure 2). This can be attributed in part to the number of trophy properties that have already traded at cap rates near, or even slightly below, 6% in the previous year. As the multi-family market continues to excel past recovery, the share of distressed transactions has faded. The amount of foreclosed properties and delinquent loans countywide decreased significantly from $97 million recorded in 2011 to $56 million recorded in November 2012, representing only 1.5% of the total multi-family distress on the entire west coast.2 This conveys the strength of San Diego’s multi-family market, highlighting it as the leading property type in rebounding from the

Fig. 2

Multi-Family Sales Volume in San Diego County
Comparing Sales of 10-99 units vs. 100 units + Sales ofVolume 10-99 Units Sales of 100+ Units

Comparing Sales Volume of 10-99 units vs. 100 units +

$3,500

Millions

$3,000 $2,500 $2,000 $1,500 $1,000 $500 $0
$942 $938 $2,022

$1,324

$2,115

$981
$349 $902 $487 $416 $446 $295 $225 $517 $755 $387 $350 $370

$1,098 $692 $714

$215

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011 2012YTD

Source: CoStar. Sold Transactions Only. 2012YTD as Source: CoStar. Sold Transactions Only. 2012YTD asof of 12/18/2012. 12/18/2012.

recession. The historically low cost of debt and strengthening market fundamentals has also fueled this sector’s recovery. Current 10-year fixed rates have fallen below 4.0% and lenders have become aggressive as more debt providers have entered the market. Given the low interest rates and continued growth in the apartment sector, various sources of new capital have entered the debt-placement market from CMBS lenders, life insurance companies and commercial banks. In 2012,
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competition between buyers and sellers increasingly became fierce and will only continue to heat up in 2013. The multi-family sector has emerged as one of the most sought after property types for investors, with focused interest on key urban properties in prime markets. This held true in 2012 for both private investors and national REITs, whose fierce competition in the acquisition of trophy properties have driven cap rates to all-time lows. Ample sources of low-interest financing combined

58

San Diego Multi-Family Forecast
with limited supply and a shift in attitudes towards rent vs. own will continue to position San Diego as one of the hottest multi-family markets in the country throughout 2013. Development & Construction: In 2012, San Diego witnessed a surge in groundbreaking developments. Multi-family starts continued to ramp up as developers broke ground on a number of projects throughout the county. Noticeably, the majority of projects that have begun construction are located in San Diego’s downtown area, predominantly in the East Village and Little Italy neighborhoods (Figure 4). This is no surprise as these areas offer the walkability, access to public transportation, and
Fig. 3
Property Legacy Apartment Homes Forest Park Apartments Adagio Hidden Hills Apartments Villa Real Apartments Broadway Lofts SF 351,336 253,566 116,054 141,980 92,930 75,436 Seller/Buyer Garden Communities LLC/R&V Management Corporation R&V Management Corporation/JH Real Estate Partners, Inc. Davlyn Investments, Inc./R&V Management Corporation R&V Management Corporation/JH Real Estate Partners, Inc. Helix Associates/Triumph Properties Group Genton Property Group/AIMCO

an urban “live, work, play” lifestyle coveted by the young generation of renters. This demographic is the target behind such developments as the IDEA district - a master-planned mixed-use development proposed to result in nearly three million SF of new residential, retail, hotel and office space. It will consist of 93 acres of sustainable, mixed-use development.3 The IDEA development comes on the heels of other large projects in the area, most noticeably the recently completed Thomas Jefferson School of Law and the San Diego Central Library. Projects in the East Village have positioned the area to become one of the fastest-growing and most

vibrant neighborhoods in San Diego. Multi-family developers have already begun to take notice. Pinnacle Developments, the Canadianbased company behind the popular Pinnacle Museum Tower in the Marina District, have plans for two residential towers and a park at the intersection of 15th and Island. This project will be one of the first to break ground that promises to transform the area. The two towers will consist of 965 units and over 17,000 SF of retail space.4 Vacancy Rates: San Diego has long held the distinction of being one of the most sought after places to live; a fact that is reflected in its home prices and affordability index

Key Sale Transactions 2012YTD
# of Units Price 412 338 143 154 163 84 $91,000,000 $44,500,000 $25,500,000 $21,500,000 $20,100,000 $19,700,000 Price/SF $259.01 $175.50 $219.73 $151.43 $216.29 $261.15 Price/Unit $220,874 $131,656 $178,322 $139,610 $123,313 $234,524 Submarket Mira Mesa/ Miramar East County East County Vista Carlsbad Downtown

Source: Cassidy Turley San Diego and CoStar. 2012YTD as of 11/30/12.

59
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Fig. 4

Top Projects Under Construction
San Diego County
Submarket Mira Mesa/ Mirmar Downtown Linda Vista Del Mar Hts./ Carmel Valley Downtown Downtown Downtown Chula Vista # of Units 1,848 617 533 484 264 241 224 218 Acres 6.65 1.4 13.12 7.7 1.89 1.4 0.7 10.1 Developer Garden Communities Pinnacle International Carmel Partners Garden Communities The Hanover Company Holland Partners Group Management, Inc. Property Management & Development ColRich Group/ Resmark Apartment Living ColRich Group/ Resmark Apartment Living Alliance Residential Company Anticipated Completion 2013 2014 2013 2013 2014 2015 2013 2013

Rank 1 2 3 4 5 6 7 8

Property Name Casa Mira View 15th & Island Carmel Pacific Ridge Torrey Hills Apartments Hanover Market Street 15th & Market Ariel Suites Olympic Pointe East

Location 11195 Westview Pkwy. 15th St. & Island Ave. 5945 Linda Vista Rd. Calle Mar De Mariposa & W Ocean Air Dr. 13th St. & Market St. 15th St. & Market St. 701 Beech St. Olympic Pkwy. & Wueste Rd. Olympic Pkwy. & Wueste Rd. 1902 Kettner Blvd.

9 10

Olympic Pointe West Broadstone

Chula Vista Downtown

209 201

9.5 1.4

2013 2013

Source: Peirce Eislen; Market Point Realty; CoStar

(Figure 12). The combination of housing demand and a high barrier of entry for purchasing ensure strong demand for apartments and rental communities. Vacancy rates have been steadily decreasing since the recession, peaking at 5.26% in 2007 and steadily declining to 4.5% in 2012 (Figure 6); a level considered by landlords as ideal for the industry. The North County Coastal market displayed the lowest vacancy rate of

3.87% followed by South County with 4.55% and the Highway 78 Corridor with 4.61% (Figure 7). Despite a recent burst of new apartment development in some markets, San Diego should expect to see vacancy rates reach 4.2% in 2013. This decline will be further supported by the surge in rental demand influenced by the Generation Y demographic, also known as the
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“Echo Boomers” along with the large population of aging Baby Boomers. In comparison to other product types in the market as well as other metros across the nation, although vacancy rates have increased, they have remained healthy and hovered around 5% for more than a decade. Rental Rates: San Diego has experienced nominal rent growth 60

San Diego Multi-Family Forecast
Fig. 5

Top 10 Largest Multi-Family Landlords
San Diego County
Top 10 Landlords Rank 1 2 3 4 5 6 7 8 9 10 Landlord Progress Management R&V Management Equity Residential Archstone BRE Properties, Inc. Hanken Cono & Assad Company, Inc AvalonBay Communities, Inc. Garden Communities LLC Irvine - Woodbridge Apartments AIMCO
Rankings based on SF representation. Source: CoStar.

Fig. Fig. 106
6%

Multi-FamilyVacancy Vacancy Rate in San Multi-Family San Diego DiegoCounty County
5.26%

with an average of 1% increases per year for the last five years. This year, the northern coastal market, comprised of submarkets stretching from La Jolla to Carlsbad, continued to command the highest rental rates of $1,715 per month, reflecting a 24% rent premium over the countywide average of $1,375.5 Comparing submarkets, Downtown remains the most expensive place to rent, with monthly rates averaging $1,771. Looking ahead, rent growth for multi-family units is poised for substantial increases as 2013 should see an end to this trend of moderate bumps. Some higher-end apartment communities in well-located areas have already begun to experience this growth. This trend will be further exacerbated by the modest increase in inventory in San Diego for the next several years. The County will add an average of 2,000 units a year until 2016.6 This is well below the pipeline of comparable major markets and represents less than a 1% increase to the total rental market for San Diego per year. As of October 2012, San Diego

5% 4% 3% 2% 1% 0%
2.54%

4.74% 4.37% 4.17%

4.54%

4.50%

4.20%

2.25%
1.84%

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013f

61

Source: MarketPointe Realty Advisors. (f) forecast by Cassidy Turley San Diego.
Source: MarketPointe Realty Advisors. (f) forecast by Cassidy Turley San Diego.

Cassidy Turley San Diego | www.CassidyTurley.com/SanDiego

employers added 23,500 jobs to Fig. 7 Vacancy Rate by Market San Diego County their payrolls aside from the 32,800 year-over-year jobs added in July Submarket Area September-12 March-12 September-11 East County 4.11% 4.48% 5.19% 2012, which was the largest month Highway 78 Corridor 4.61% 4.45% 4.49% for year-over-year job gains recorded Interstate 15 4.50% 4.64% 5.29% in San Diego in over 10 years.7 The Corridor North County majority of the recent job growth 3.87% 4.43% 3.54% Coastal was comprised of low to moderate San Diego Central 5.04% 4.32% 4.55% wage sectors which should fuel South County 4.55% 4.39% 4.25% Countywide 4.50% 4.43% 4.49% rental demand for the multi-family market. However, it seems as though Bedroom Category September-12 March-12 September-11 the multi-family sector is not the Studio 4.60% 3.95% 3.96% 1-Bdrm 4.25% 4.21% 4.47% only segment benefiting from recent 2-Bdrm 4.55% 4.52% 4.51% economic improvements. As of 3-Bdrm 5.23% 5.01% 4.78% November 2012, San Diego single4-Bdrm 6.06% 7.60% 3.85% family home sales were up 16% yearCountywide 4.50% 4.43% 4.49% over-year, and median home prices Fig. 6 Multi-Family Inventory in San Diego Source: Breakdown MarketPointe Realty Advisors. rose 17% annually to $408,000 – the Fig. 8 Multi-Family Inventory Breakdown largest annual increase seen in San Diego County more than a decade.8 Although San Diego has experienced a recent increase in residential sales activity and the cost to own has slightly fallen below that of renting (Figure 11), this poses no imminent threat to the multi-family sector. Due to strict lending standards enacted after the financial crisis, potential homeowners are being thwarted by cash-rich investors who are gobbling up the small amount
3-Bedroom 7.8% Studio 3.5% 4-Bedroom 0.2%

County

Studio 1-Bedroom 2-Bedroom 3-Bedroom 4-Bedroom Total Existing Inventory East County Hwy 78 Corridor Interstate 15 Corridor North County Coastal San Diego Central South County Total Future Inventory: Proposed Units

4,347 44,232 66,379 9,754 264 124,976 377 306 2,224 790 4,921 2,036 10,654

1-Bedroom 35.4%

2-Bedroom 53.1%

Source: MarketPointe Realty Advisors. Cassidy Turley San Diego | www.CassidyTurley.com/SanDiego
Source: MarketPointe Realty Advisors.

62

San Diego Multi-Family Forecast
Fig. 8

Fig. 9 Multi-Family Vacancy Rates San Diego County Comparing Vacancy Rates of properties builtin before 1998 vs. after 1998 Comparing Vacancy Rates of properties built before 1998 vs. after 1998
8% 7% 6% 5% 4% 3% 3.4% 4.7% 4.9% 4.6% 4.8% Built before 1998 Built after 1998 7.1%

Multi-Family Vacancy Rates in San Diego County

4.2%

4.1%

4.5%
3.8%

of supply and capitalizing on rock bottom prices. In addition, lingering fears of a lack of job security have driven potential homeowners, even those who have the financial means to purchase, to remain renters so they can retain the flexibility to relocate if employment changes in the future. Therefore, despite the recent signs of modest recovery in the singlefamily housing market, this does not necessarily translate to less demand for apartment rentals. Moving into 2013, landlords should expect to see at least a 3.5% bump in rental rates and a spike in operating revenues assuming the job market continues to improve and supply levels remain below demand. Demographics & Demand: San Diego remains one of the strongest multifamily markets nationally fueled by its moderate economic improvement, numerous barriers to entry, limited supply, and positive demographic trends consisting of a growing rental population (Generation Y and Baby Boomers). In 2012, San Diego witnessed a decline in unemployment from 9.8% a year ago to 8.6%

2%
1% 0%

1.9%
1.7%

2.4% 1.7%

2006

2007

2008

2009

2010

2011

2012YTD

Source: MarketPointe Realty Advisors.

Source: MarketPointe Realty Advisors.

Fig. 9

Fig. 10 Comparing

Comparing Rental Rates of properties built before 1998 vs. after 1998
Built before 1998 Built after 1998

Multi-Family Rental Rates in San Diego County Multi-Family Rental Rates San Diego County Rental Rates of properties built in before 1998 vs. after 1998

$2,000

$1,800

$1,812 $1,751

$1,760

$1,816 $1,749

$1,843

$1,690
$1,600

$1,400
$1,239 $1,216 $1,205 $1,243 $1,251

$1,200

$1,159

$1,197

$1,000

2006

2007

2008

2009

2010

2011

2012YTD

63

Source: MarketPointe Realty Advisors.

Source: MarketPointe Realty Advisors.

Cassidy Turley San Diego | www.CassidyTurley.com/SanDiego

currently. This rate is forecasted to continue to moderately decline to a near pre-recessionary level of 5.4% by 2016 (Figure 13). In San Diego, the Echo Boomer generation (ages 16–34) is the largest in the county – currently estimated to be over 959,000 people in which 460,000 are of the prime renting age (ages 25–34)(Figure 14 and 15). As this generation enters the housing market, they are faced with high student loan debt, less job certainty, stricter lending standards when purchasing a home, and a shift in lifestyle preferences such as delaying marriage. All of these factors contribute to a generation that is more apt to rent than to buy out of necessity and convenience. Countywide, this age group is forecasted to increase by 51,856 people or 11.3% by 2020. With San Diego’s influx of high tech and bio tech jobs luring a young highly skilled labor force, this cohort will continue to supply the demand for rental communities, especially for Class A properties. On the other end of the spectrum many of the parents of Generation Y,

The Baby Boomers (age 45–64), are now empty nesters. Instead of trying to balance an abundance of living space with a crippled retirement account through their golden years, many are deciding to downsize the family home and rent in multi-family communities. Due to increasing life expectancy and medical advances, demand for senior housing is on the rise. In hindsight, the 65 and older population is forecasted to increase by 143,023 people or 38.0% by 2020. Regardless of the recent rebound of
Fig. 11

the single-family purchase market in San Diego, the multi-family rental market boasts strong fundamentals that will match or outpace the supply of multi-family inventory in the county. 2013 will see vacancy rates continue their decline towards pre-recession lows and will see rents break free of the modest bumps of the past several years.
1. 2. 3. 4. 5. 6. 7. 8. CoStar Group, Inc. Real Capital Analytics, Inc. http://ideadistrictsd.com/ http://www.ccdc.com/projects/major-downtown-projects/ projects-landing-page/east-village/804-15th-a-island.html MarketPointe Realty Advisors, Rental Trends September 2012 “How many rentals will San Diego add until ’16?”, San Diego Union Tribune, November 7,2012 U.S. Department of Labor, Bureau of Labor Statistics San Diego Association of Realtors

Cost to Rent vs. Own in San Diego County Fig. 11 Cost to Rent vs. Own in San Diego County
Avg. Price to Rent: an Average for All Bedroom Categories Countywide Avg. Price to Own an Existing Single Family Home - an Average Mortgage Payment*

$3,500

$3,015 $2,858 $2,593

$2,927

Payment

$2,500
$1,998 $1,838

$1,855
$1,551 $1,520

$1,500
$1,158 $1,195 $1,241 $1,290 $1,343 $1,321

$1,392 $1,357

$1,338 $1,375

$1,356 $1,409

$1,469 $1,445

$1,310

$1,061

$1,123

$500

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013f 2014f

Source: Market Pointe Realty California National Association of and Realtors, Freddie Mac. Source: Market Pointe Realty Advisors, Advisors, California and and National Association of Realtors, Freddieand Mac. (f) forecast by Cassidy San Diego. Beacon Economics 2012 San Diego Forecast. Economic Forecast. (f) forecast by Cassidy Turley Turley San Diego. Beacon Economics 2012 San Diego Economic *Avg. county mortgage payment is calculated by taking the national average 30 year fixed rate and median sales *Avg. county mortgage payment is calculated by taking the national average 30 year fixed rate and median sales price of an existing single price of an existing single family home in San Diego County. Assumes 20% down payment. family home in San Diego County. Assumes 20% down payment. Cassidy Turley San Diego | www.CassidyTurley.com/SanDiego

64

San Diego Multi-Family Forecast
Fig. 12

Housing Affordability in Comparison

California Association of Realtors® Traditional Housing Affordability Index (HAI)
State/Region/County California Single-Family Existing Home CA Condo/Townhome Los Angeles Metropolitan Area Inland Empire San Francisco Bay Area United States Q3 2012 49 60 51 68 35 67 Q3 2011 51 62 53 70 35 67 Q3 2011 51 62 53 69 38 66 HAI 49 60 51 68 35 67 Median Home Price $339,860 $258,070 $314,090 $193,910 $568,040 $186,100 Monthly Payment Including PITI $1,650 $1,250 $1,520 $940 $2,750 $900 Minimum Qualifying Income $65,810 $49,980 $60,820 $37,550 $110,000 $36,040

Southern California
Los Angeles Orange County Riverside County San Bernardino San Diego Ventura 42 34 63 77 43 47 49 35 65 78 44 48 42 33 65 77 42 45 42 34 63 77 43 47 $355,700 $560,320 $226,660 $146,070 $394,390 $432,540 $1,720 $2,710 $1,100 $710 $1,910 $2,090 $68,880 $108,510 $43,890 $28,290 $76,370 3-Bdrm

The California Association of Realtor’s (C.A.R.) Housing Affordability Index (HAI) measures the percentage of all households that can afford to purchase a median-priced, singlefamily home in California. The Index is considered the most fundamental measure of housing well-being for home buyers in the state. According to the 3Q12 data, HAI in San Diego was 43 compared to 67 in the U.S. and 49 in California. In comparison, the HAI in San Diego was 11 in 2006, 16 in 2007, 36 in 2008, 38 in 2009, 40 in 2010 and 45 in 2011. Source: California Association of Realtors® (C.A.R.) Release date: 11/12/2012.
Fig. 13

Unemployment Rate in Comparison
Fig. 13
San Diego Santa Ana Los Angeles

Unemployment Rate in Comparison
Riverside U.S.

16% 14% 12% 10% 8% 6% 4% 2%

2005

2006

2007

2008

2009

2010

2011

2012f

2013f

2014f

2015f

2016f

65

Source: Moody’s Economy.com www.economy.com. Precis METRO August 2012.

Cassidy Turley San www.economy.com. Diego | www.CassidyTurley.com/SanDiego Source: Moody’s Economy.com Precis METRO August 2012.

Fig. 14

Population by Age Group 2010 vs. 2020
San Diego County

California Association of Realtors® Traditional Housing Affordability Index (HAI)
Total Population 2010 2020 Net Change % Change 2010 2020 3,095,313 3,535,000 439,687 14% 100% 100% 14 & younger 596,168 709,748 113,580 19% 19.3% 20.1% increase 15-19 225,095 238,916 13,821 6% 7.3% 6.8% decrease 20-34 741,672 762,113 20,441 3% 24.0% 21.6% decrease 35-44 420,563 432,371 11,808 3% 13.6% 12.2% decrease 45-59 611,079 660,017 48,938 8% 19.7% 18.7% decrease 60-64 149,311 209,637 60,326 40% 4.8% 5.9% increase 65-74 180,554 309,111 128,557 71% 5.8% 8.7% increase 75 & older 170,871 213,087 42,216 25% 5.5% 6.0% increase

Net and Percent Change by Age Group from 2010 to 2020 Population by Age Group as a Percent of Total Population in 2010 and 2020
Between 2010 & 2020, this age group is forecasted to

Source: SANDAG, Regional Growth Forecast.

Fig. 15

Fig. 15 Population by Group Age Group in San DiegoCounty County Population by Age in San Diego
2010 2020
Year Total Population 2010 3,095,313 2020 3,535,000 Net Change 439,687 % Change 14%

800,000
19%

3%

8%

600,000

3%

400,000
71% 6% 40% 25%

200,000

0

14 & younger

15-19

20-34

35-44

45-59

60-64

65-74

75 & older

Source:Source: SANDAG, Regional Growth Forecast. SANDAG, Regional Growth Forecast.

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About The Partnership
About the Partnership
Cassidy Turley San Diego’s research capabilities are built on our local expertise in the markets that we serve. Our extensive market coverage across San Diego County remains a critical component in understanding the dynamics of the commercial real estate market. Our data collection and tracking process for properties and transactions as well as our broad capabilities to serve all aspects of real estate transactions (from investment to leasing to management) provide us with a unique opportunity to join forces with SDSU’s Corky McMillin Center for Real Estate and The National University System Institute for Policy Research to develop an accurate and informative forecast for the 2013 San Diego commercial real estate market. These academic institutions provide valuable, unbiased and credible information developed from their vast array of statistical models and methods of data collection. Together, we analyzed trends and relationships between key economic indicators and used that knowledge to predict the direction of the market. This information will help our professionals and clients develop a better understanding of important issues and trends that impact commercial real estate locally and nationally.

About The Corky McMillin Center for Real Estate at San Diego State University
The Corky McMillin Center for Real Estate is part of the College of Business Administration at San Diego State University. It was developed to further real estate education and research across the University. One of the primary missions of The Center is to promote high quality real estate research because research on current real estate issues enhances understanding of markets, strategies and policies for students and the industry.

About The National University System Institute for Policy Research
The National University System Institute for Policy Research is a groundbreaking, independent economic think tank that promotes high quality economic, policy, and public-opinion research to improve the efficiency and effectiveness of local governments in the San Diego region. The Institute continually conducts research and publishes articles, policy briefs, and other materials about regional issues, including municipal government, economic policy, housing, transportation, infrastructure, and fire preparedness.

67
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The College of Business Administration is fully accredited by AACSB International - The Association to Advance Collegiate Schools of Business

SDSU AD
Mayor Jerry Sanders (left) presents The Corky McMillin Center for Real Estate Day proclamation to Mark McMillin (center) and Scott McMillin.

Producing Top Talent Real Estate Professionals Since 1958
Dedicated to Enhancing Real Estate Education, Promoting Research & Adding Value to the Real Estate Industry
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11355 N. Torrey Pines Road La Jolla, CA 92037

www.nusinstitute.org

The National University System Institute for Policy Research, LLC, (NUSIPR) is a non-partisan organization that formulates and promotes high quality economic, policy, and public-opinion research so as to improve the efficiency and effectiveness of local governments in San Diego County and to improve the quality of life enjoyed by the region’s citizens. For more information visit www.nusinstitute.org The Institute is an affiliate of the National University System established in 2001 by National University to meet the emerging challenges and demands of education in the 21st century. The System is uniquely aligned to connect a diverse population of students to a network of innovative educational programs that are relevant to their lives, careers, and the marketplace and are delivered in a format that respects competing life priorities. For more information visit www.nusystem.org
Cassidy Turley San Diego | www.CassidyTurley.com/SanDiego

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San Diego - UTC (Headquarters) 4350 La Jolla Village Drive, Suite 500 San Diego, CA 92122 T | 858.546.5400 F | 858.630.6320 San Diego - Carlsbad 1000 Aviara Parkway, Suite 100 Carlsbad, CA 92011 T | 760.431.4200 f | 760.454.3869 San Diego - Downtown 350 10th Avenue, Suite 910 San Diego, CA 92101 T | 619.515.0017 f | 619.515.0020 San Diego - Otay Mesa 8780 Sherwood Terrace San Diego, CA 92154 T | 619.661.0657 f | 619.661.1869 San Diego - East County 2295 Fletcher Parkway, Suite 200 El Cajon, CA 92020 T | 619.462.4500 f | 619.462.7100

www.cassidyturley.com/sandiego

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About Cassidy Turley Cassidy Turley is a leading commercial real estate services provider with more than 3,700 professionals in more than 60 offices nationwide. The company represents a wide range of clients—from small businesses to Fortune 500 companies, from local non-profits to major institutions. The firm completed transactions valued at $22 billion in 2011, manages 455 million square feet on behalf of institutional, corporate and private clients and supports more than 28,000 domestic corporate services locations. Cassidy Turley serves owners, investors and tenants with a full spectrum of integrated commercial real estate services—including capital markets, tenant representation, corporate services, project leasing, property management, project and development services, and research and consulting. Cassidy Turley enhances its global service delivery outside of North America through a partnership with GVA, giving clients access to commercial real estate professionals in 65 international markets. Please visit www.cassidyturley.com for more information about Cassidy Turley. Cassidy Turley provides regional real estate services with local market leader Cassidy Turley San Diego. The company’s dominant market presence includes more than 160 professionals and staff in five local offices and recorded more than $1.2 billion in transactions in 2011. For more information about Cassidy Turley San Diego, please visit www.cassidyturley.com/sandiego or contact Dan Broderick, President and CEO of Cassidy Turley San Diego.

Cassidy Turley San Diego | www.CassidyTurley.com/SanDiego