In San Francisco, Prices
Rise for Office Space

Not long after oil prices collapsed in 1986, commercial real-estate markets from Houston to Dallas to Denver followed suit.

When the tech-stock bubble burst in 2000, San Francisco seemed destined for the same fate. The city's economy was reeling, buildings sat empty and buyers disappeared. Just five top-quality downtown office buildings changed hands from 2001 through 2003.

One of the buyers was Stuart Shiff, whose firm in 2003 purchased two nearly empty downtown office towers -- once filled with dot-com tenants -- for $79.5 million.

Two years later, those buildings are on the market again, for four times what Mr. Shiff paid. More than a dozen bidders are seriously competing for the deal, brokers say, and banks are offering liberal financing. Based on prices recently paid for similar buildings, Mr. Shiff will likely get what he's asking for. "There's something bubbling here," says Mr. Shiff. "San Francisco is about to peak."

The city's commercial real-estate market has made a surprising comeback. Since January 2004, 53 office buildings -- about one-third of downtown's total square footage -- have changed hands, often for more than they fetched during the tech boom. By contrast, real-estate markets in cities such as Dallas and Houston were moribund for years after falling oil prices battered their economies in the 1980s.

San Francisco's rebound says a lot about investors' current infatuation with real estate and about the vast amount of available capital flowing around the world. Office rents in San Francisco are half those in New York -- but investors are paying two-thirds of New York prices to buy the properties. The problem facing these new buyers: Charging enough rent to justify the high prices.

Some veteran real-estate executives say that as in the tech boom, these investors are paying prices that can't be justified by the market's fundamentals. "San Francisco is improving. But it just has a ways to go," says Robert Bach, national director of market analysis for real-estate broker Grubb & Ellis.

Many San Francisco office buildings remain empty, and the city's vacancy rate is a lofty 16.5%, compared with 8.9% in New York City and 7.1% in Washington. The city's weak job growth means prospects don't look much better. In the past year, just 8,000 new jobs were created in San Francisco, Mr. Bach says, while in the strong New York City market, 57,400 jobs were created, and Washington added 79,400 jobs.

Kevin Brennan, an executive vice president at commercial real-estate brokerage firm Studley, estimates that the San Francisco economy will have to create 60,000 new jobs -- including 45,000 white-collar posts -- before demand increases to a point where landlords can raise the rent. "The buildings that have traded can't afford to compete with the buildings next door," Mr. Brennan says. "Any building that sold is going to have a problem."

While Mr. Shiff's firm, Divco West Properties, had little competition for buildings in 2003, these days new buyers are appearing at every property sale. In June 2004, when an interest in an office building at 425 Market St., in the financial district, hit the market, there were fewer than 10 bidders. The property sold for about $300 a square foot to Walton Street Capital, according to sales brokers at Jones Lang LaSalle Inc. When the broker tried to sell a nearby office building in July 2005, it attracted 30 bidders and sold for nearly $370 a square foot. Now, Walton Street Capital says it is shopping 425 Market St. again, and industry officials say the firm is asking as much as $450 a square foot.

In 2004, a group of New York investors led by Mark Karasick bought the Bank of America Tower at 555 California St. for $489 a square foot. In September, he sold the building to a group of Hong Kong investors partnering with developer Donald Trump for $583 a square foot, for a $171 million profit.

Buyers are finding ready cash from lenders. Wachovia Corp., a leading commercial lender, has made about $360 million in loans for office properties in the Bay Area this year, compared with $106 million in 2004.

"Wall Street loves San Francisco," says Alan Goodkin, a managing director with financial advisory firm Ackman Ziff, whose business has advised on $689 million in San Francisco real-estate deals this year, compared with $60 million in deals in the city in 2004. He echoes the view of many that San Francisco could have a strong rebound. "You're buying in a market that has been too depressed for too long," Mr. Ziff says.

San Francisco's comeback has been driven by a number of factors, including investors' infatuation with hard assets such as real estate in the wake of the dot-com bust. In addition, landlords in the city hadn't overloaded on debt, and many were institutional investors with long time horizons, so there was little panic selling. The tech companies that went bust had often paid hefty security deposits, which helped the building owners weather the slowdown. In the late 1990s, space was so tight that many tech companies signed long leases at bubble-era rents.

At some points, though, it was unclear whether San Francisco would suffer the same fate as Dallas and Houston, which are still struggling to revive their downtowns. Empty office space flooded into the San Francisco market for three straight years, leaving more than one-fifth of the city's office buildings empty. Rents tumbled and unemployment jumped, peaking at 7.5% in the summer of 2003.

But San Francisco has a history of strong rebounds, helped by its limited land and the Bay Area lifestyle. Those arguments led Mr. Shiff to buy the two towers, which had served as the headquarters for oil company Chevron Corp. In 1999, Tishman Speyer Properties paid $189 million to buy the buildings from the oil company, which had merged with Texaco in 1999 and moved out of the city. Tishman had filled the building with dot-com tenants, and after the bust, defaulted on its loan.

Mr. Shiff and business partner David Taran started investing in Bay Area real estate in the mid-1990s by buying 10 Silicon Valley office towers. They purchased acres of land in Coyote Valley in South San Jose, and then cast their eyes on the San Francisco market following the tech bust, eventually grabbing the Chevron buildings for $79.5 million from the banks that had taken them back from Tishman Speyer.

Divco, their firm, tried to lure tenants with wining, dining and most of all cheap rents. It found its first tenant in October 2004, when it leased 120,000 square feet to advertising agency Omnicom Group Inc. Smaller but prestigious tenants such as the James Irvine Foundation and international document company Océ Business Services also moved in.

Now, bidders willing to pay high prices are elbowing out some of San Francisco's most experienced buyers. Investment firm TIAA-CREF, which has invested in San Francisco real estate for 30 years, was outbid on a half-dozen recent deals by rivals, including foreign investors, wealthy individuals and other institutional investment funds.

Longtime landlord Douglas Shorenstein, whose family once owned a quarter of San Francisco's office buildings, is worried enough about the state of the market that he says he is redirecting his family's investments toward Boston, Washington and outlying parts of the Bay Area for better returns. Since 1992, the 50-year-old head of his family's real-estate fortune has invested more than $3.9 billion in money from his family and other investors. Mr. Shorenstein describes himself as a "natural-born worrier." Since 2004, his family has sold five major San Francisco office buildings.

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