San Francisco Market
Is Gaining Momentum

It isn't yet a new Gold Rush, but real-estate deal makers have begun placing some big bets on a recovery in San Francisco.

The city, a symbol of the technology-stock boom and bust, still is staggering, but after years of virtually no high-end real-estate action, investors are snapping up quality office buildings at a record pace.

Eleven so-called Class A buildings have sold in San Francisco this year, compared with just two in all of the previous four years. Another five are under contract and should close soon, and at least six more are on the market. That's a contrast to a year ago, when virtually no high-quality buildings were for sale.

And some buildings have been getting top dollar. Last month, Shorenstein Co. announced it had liquidated its 50% stake in one of the city's trophy office buildings, the Bank of America Center, for what some estimate was at least $400 million. In August, securities firm Morgan Stanley purchased the nearly 611,000 square-foot Hills Plaza building from closely held Shorenstein for $197 million, or $322 a square foot. And Cousins Properties Inc. and Myers Development Co. sold the 379,330-square-foot 55 Second St. building last month to Hines Interests LP for $146 million, or about $386 a square foot.

All told, investors plunked down nearly $2.1 billion for San Francisco office properties in all classes in the city's central business district during the first three quarters of this year, nearly six times the amount during the same period last year, according to Real Capital Analytics Inc., a real-estate research company based in New York. Another $587 million or so of office properties are under contract to be purchased, according to Cushman & Wakefield Inc., a New York commercial real-estate services company. Nationwide, office-property sales rose to nearly $48 billion this year through September, compared with $31 billion a year earlier.

Overall, however, San Francisco's commercial real-estate market is still a shambles: Vacancies are at 21%, well above the national average. The vacancy rate is about 13 times what it was at its low point, according to Reis Inc., a New York commercial real-estate research firm. Rents have plummeted by more than 60% to $25.91 a square foot per year in the third quarter from a peak of $65.32 a square foot in the fourth quarter of 2000.

But most of the damage over the past few years has been inflicted on owners of Class B and C office buildings, which are older and lower quality. Many of these owners sold at distressed prices after their buildings emptied out. After the dot-coms crashed, businesses found they could trade up to better office space for the same rent or less. That helped owners of Class A buildings, who also were bolstered by long-term leases and a more-stable tenant base, ride out the storm and wait for a good time to sell.

That time appears to be now.

Late last year, the bottom stopped falling out of the San Francisco real-estate market, and the office-vacancy rate began to level off. Some businesses have taken advantage of the dirt-cheap rents to move into the city for the first time. Gymboree Corp., a nationwide children's' retailer, took a 162,000-square-foot space in San Francisco earlier this year, for example, and is moving its headquarters there from suburban Burlingame, Calif., about 17 miles south.

The city also has seen the financial-services industry add jobs. Law firms have been expanding and even technology firms are beginning to take more space.

The fear of low valuations because of the devastated office market kept owners from putting their properties up for bid, says Russ Sherman, senior director for investment sales at Cushman & Wakefield. But "some major sellers like Shorenstein decided to test [the market], and they were pleasantly surprised by the offers," he says.

Hines Interests LP, a Houston property investor, developer and manager, and the California Public Employees' Retirement System recently leapt into the mix with a three-building portfolio of 1.4 million square feet they put up for bid through their joint venture, National Office Partners LP. Each of the three office buildings in San Francisco put up for sale received about 20 bids last month, says Daniel MacEachron, portfolio manager for National Office Partners and a Hines senior vice president based in San Francisco

Hines isn't bailing out of San Francisco, however. A few months ago, Hines was a buyer, acquiring two, 25-story office buildings at 55 Second St. and 101 Second St. from Atlanta-based Cousins Properties and San Francisco-based Myers Development for $287 million. The nearly 388,000-square-foot 101 Second St. building sold for about $362 a square foot.

Even some buildings with large empty spaces are being put on the market.

Yet a pickup in a battered market like San Francisco has some real-estate investors worrying that the national market may be in danger of overheating again.

"The real-estate capital markets are extremely frothy," says Michel Siefer, a managing director in San Francisco for Jones Lang LaSalle Inc., a Chicago commercial real-estate services company.

But San Francisco has long been one of the country's most-coveted markets. And when investors look at markets such as New York and Washington, where buildings are going for $500 to $600 a square foot, San Francisco, with buildings going for $300 to $400 a square foot, is attractive.

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