The Impact of an Economic Slowdown on San Diego’s Commercial Property Market

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From the Desk of Eric Northbrook

The country got a wake-up call on April 28th when the first estimate of Q1’s GDP had the US economy contracting at an annualized rate of 1.4%. Most experts expected a sluggish quarter of growth, but none that I know of predicted an actual decline in economic activity. I was just as surprised as everyone else and it made me wonder if we are headed for recession and, if so, how that would impact commercial real estate here in San Diego?

Technically speaking, a recession is defined as two consecutive quarters of negative economic growth. We won’t get our first look at Q2 GDP until the end of July, so it is way too soon to be making any predictions. However, I believe in hoping for the best but being prepared for the worst, so I think it is wise to give serious thought to the impact of a recession on San Diego commercial real estate should one occur.

Right now, inflation is the biggest concern, as it is running at a pace we haven’t seen since the early 1980s. High inflation hurts us all, especially those who are already struggling to make ends meet. It changes the psychology of consumer decision-making, as hard-working San Diegans are being forced to divert discretionary spending on goods and services to life essentials like food and fuel. If it persists, inflation will eventually impact profitability in multiple business sectors.

That said, San Diego stands to fare better than most major metro areas because of two of its prominent business sectors: defense and life sciences.

For decades, San Diego has been one of the nation’s largest maintenance hubs for the US Navy. As such, it provides a steady flow of economic activity for thousands of San Diego businesses under contract to provide a wide variety of services. US Navy ships must undergo scheduled routine maintenance to remain battle-ready at all times. The funding for all of that work comes from the Department of Defense and can be counted on as a reliable source of economic fuel for San Diego under all economic conditions. The region’s housing, industrial, retail and office sectors are supported by the tens of thousands of good-paying jobs the defense industry provides. That, in turn, supports the commercial real estate market by keeping vacancy low and demand strong enough for investors to prioritize property ownership in San Diego.

The life sciences industry is the other powerful engine driving economic growth in San Diego, especially in the central part of the county near UCSD. San Diego has long been recognized as a hotbed of growth in the life sciences sector, but the pace of expansion has accelerated in recent years. There just isn’t enough space to accommodate the pace of growth, and developers are responding by re-purposing over 5 million square feet of office and industrial land and buildings for life science users who are starved for specialized laboratory facilities. In terms of economic support for the San Diego area, it is important to note that much of the funding for life science operators comes from all over the world in the form of venture capital dollars.

So, when you add all the defense and life science funding that comes from outside the region to the diverse local business base and a highly educated workforce, you have a regional economy that is about as well insulated from recession as any other major metro market in the country. To be sure, fighting off the effects of inflation and higher interest rates will be a challenge. The Fed is taking drastic action to put the brakes on runaway prices, and that medicine alone may be enough to send the country into recession. We just don’t know yet, but if that were to happen, San Diego is in a good position to weather that storm, and, with the help of the defense and life sciences sectors, it is likely to emerge from an economic downturn with good momentum.