San Francisco

The City by the Bay thrives with lots of development opportunities and a hot investment market.

Job growth is the big news in the Bay Area," says Gary Lucas, senior vice president/division manager of Marcus & Millichap Real Estate Investment Brokerage Co. Fueled by increased opportunities in business services, engineering, finance and communications, the San Francisco MSA gained almost 39,000 jobs, or 10% of the new jobs in the state during 1996. Personal income is on the rise, and average annual pay in the San Francisco MSA increased 4% to rank third in the nation at $37,975.

Not only are the office and industrial sectors as tight as they've been in years, but other projects like new ballparks for the Giants and 49ers as well as Catellus' 300-acre Mission Bay mixed-use complex and the Yerba Buena Gardens neighborhood are stirring up activity in the retail/entertainment, hotel and multifamily markets.

"Entertainment-oriented tenants and projects dominate the commercial development activity in San Francisco," says Jill J. Paul, vice president in the San Francisco office of CB Commercial Real Estate Services Group Inc. "With over 16 million tourists, 30,000 hotel rooms and an estimated $5.1 billion spent annually by tourists, there is no mystery why the entertainment activity has been so strong."

"I think San Francisco is doing really well, but there's still a way to go," says Mara Brazer of the San Francisco Partnership, a joint venture between the mayor's office and the local business community. "It's very exciting, because for the first time in a long time, there are a lot of opportunities for real estate development in the city. If you want to be in an urban center, this is a great time to invest in San Francisco."

Office space is hard to find "The investment market is absolutely booming," says Phil Tippett with CB Commercial. "It's probably one of the hottest in the country. People are to the point where they're flipping buildings in escrow and making money."

Significant office transactions this year have included the $105 million sale of 444 Market Street by Merrill Lynch to Equitable Opportunity Fund, plus Equity Office Properties' $80 million purchase of 201 Mission Street from GE Investments and its $105 million One Maritime Plaza buy from JMB Properties.

Downtown San Francisco has seen no new office construction since 1991 and, with the resurgence of financial service and headquarter companies as well as the emergence of the technical sector, demand for space is strong, vacancies are at an all-time low and rents are at an all-time high.

Only 1.3 million sq. ft. is vacant out of a total of 41.2 million sq. ft. of Class-A and -B buildings tracked by Grubb & Ellis. The average asking lease rate for Class-A and -B office space combined increased 8%, finishing second quarter '97 at $32.07 per sq. ft., according to G&E, which predicts that average asking lease rates for Class-A and -B space combined will continue to rise and reach $35 per sq. ft. by the end of the year. G&E also predicts that by the end of the year, the vacancy rate for Class-A space will be below 1%.

Whitney Cressman Ltd. (which includes Class-C for a total market inventory of approximately 59 million sq. ft.) places third-quarter absorption for the downtown market at 324,943 sq. ft., with overall 1997 absorption at 1.4 million sq. ft. and a vacancy rate for the third quarter of 4.75%, including A, B and C space.

"It's very difficult to find space right now in the Class-A towers in the prime financial district for a large block of space," Tippett says.

"It used to be you would negotiate, negotiate and try and just hammer the landlord and get a great deal, but now it's a question of getting in, getting it tied up and getting the deal done before you lose it to someone else," Tippett says. "A lot of time the price will get bid up on office leases."

Charles Schwab & Co. certainly has been the most active space-user during 1997, committing -- in the largest office lease downtown in more than three years -- to take all 359,000 sq. ft. at 211 Main Street. The CAC Group represented the owner, San Francisco's Booth family, in the deal, which has been reported at $217 million. Earlier in the year, Schwab, which has been represented by Colliers Damner Pike, renewed for 156,000 sq. ft. at 333 Bush Street, expanded into 20,260 sq. ft. at 580 California Street and expanded yet again with 165,000 sq. ft. at 345 California Street.

Looking ahead, CAC forecasts that 1998-1999 will be challenging years as tenants adjust to the market, citing more out-migration is anticipated and expecting that new construction will address some needs.

Hotels on the rise To help accommodate the increase in travelers passing through the San Francisco airport -- which, according to William F. Gower, McCarthy senior vice president and San Francisco regional manager, saw a 13% increase in international travelers -- a new $856 million international terminal is under way and scheduled to open in spring 2000.

Gower also notes that, following voter approval of a hotel tax hike last year to pay off bonds for financing, a new convention facility will be built at 5th and Howard streets, near the city's existing convention spaces at Moscone Center.

Across the board, San Francisco's hotel-motel business has been on an upward climb, at least through the first five months of the year. According to PKF Consulting, San Francisco, ADR was up 12.3%, from $112.98 in 1996 to $126.91 in 1997, and occupancy was up 5.2% from 72.8% in 1996 to 76.6% in 1997.

In fact, according to Coopers & Lybrand, from first quarter 1996 to first quarter 1997, San Francisco was the U.S. city with the fastest-rising hotel rates.

All this is leading to thoughts of construction, after eight years of no new hotels downtown.

First on the scene will be Phoenix-based hotel REIT Starwood Lodging Trust, which acquired the site and development rights to construct a 30-story, 423-room hotel across the street from the Moscone Convention Center.

Omni Hotels also plans to convert the 500 California St. office building, which it bought from Jaymont Properties for $34.65 million, into a 630-room Omni San Francisco Hotel luxury property.

And Union Pacific Railroad Co. put its own 315,000 sq. ft. One Market Street property on the block for another possible hotel conversion, although Curtis Davis, of Grubb & Ellis' Hospitality Services Group, indicated that office or residential redevelopment are other potential uses.

There's also talk of another potential project at Third and Mission by Patriot American, a Dallas-based hotel REIT.

Apartments continue strongly Throughout the Bay Area, apartments continued their strong performance as a solid investment vehicle, according to Lucas of Marcus & Millichap.

Apartment rents averaged $1,568 at the beginning of the second quarter -- a 26% jump over 1995, Lucas reports. Occupancy levels, which peaked in 1996 at 98%, decreased slightly to 96.7% in '97.

As far as sales go, the price has hit an all-time high, according to Lucas, averaging $121.83 per sq. ft. and $84,160 per unit in 1996. Through midyear 1997, the average price per unit dropped to $71,834, he notes.

Despite a 211% surge in construction permits in San Francisco, Lucas predicts that the multifamily housing shortage will not be alleviated, as local government policies continue to discourage housing development.

Regardless, there are a few multifamily projects on the boards: Catellus is building at least 6,000 units of housing; Whitney Cressman represented Bay Apartment Communities in its acquisition of a 201-unit residential development site at Beale and Harrison; and TRI Financial Corp. is providing a 40-year, $42 million FHA-insured loan to finance One Embarcadero South, a 233-unit multifamily complex being developed by Urban West Associates overlooking the new Giants baseball stadium and a marina on the bay.

Industrial sees new construction According to Gower of McCarthy, industrial vacancies in much of the greater San Francisco area are the lowest of any U.S. market, giving rise to new construction. In 1997, 8 million sq. ft. of speculative and build-to-suit industrial space is expected to be added to the market, he says.

Lucas of Marcus & Millichap agrees that this is the second year of high performance for industrial. As manufacturing jobs have grown, the demand for industrial warehouse and R&D space in the Bay Area has surged and, as a consequence, rents have increased, occupancy has tightened and new development is under way.

"The logical progression and trend of industrial relocation that has occurred in the last decade from San Francisco to South San Francisco or to the East and North Bay where land prices are more inexpensive and land rates are lower," says Ed Kitts with Grubb & Ellis.

"Where the city has missed the boat is that most large users have already moved out of San Francisco," Kitts says.

"We're seeing rates in south San Francisco and on the peninsula are getting closer to what they are in San Francisco. The vacancy rate on the north peninsula is about 3%," Kitts says. He notes that there has been a transition of some industrial space to other uses, like big-box retail, multi-media or office.

Retail centers around entertainment Much of the retail activity in San Francisco involves projects with entertainment-related components.

New Pacific Bell ballpark will play host to an estimated 2.6 million attendees per year and will have retail, restaurants and interactive entertainment as part of the Pavilion Building at the corner of Third and King streets.

The Catellus retail/entertainment project adjacent to the ballpark consists of approximately 400,000 sq. ft. anchored by a multilevel cineplex, as well as apartments and parking.

Candlestick Mills has just been approved to include 1.4 million sq. ft. of retail with restaurants and entertainment.

And Sony's new "Metreon" project at Yerba Buena Gardens, scheduled for a late 1998 opening, will include a 15-screen Cineplex, an IMAX theater, a Discovery Channel store, various forms of interactive play for children and interactive entertainment, live performance venues and restaurants.

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