San Francisco: many investors are readily leaving their hearts and their dollars in the city by the bay

A business boom in San Francisco has erased most traces of the early-'90s recession. Analysts predicted a turnaround beginning this year, but the speed of recovery, especially since late spring, has caught many people by surprise.

"We've seen a wide variety of institutional and entrepreneurial investors returning to this market and looking for product," says Bert Sandell, managing director/Northern California at Trammell Crow Northwest in San Mateo.

Hessam Nadji, vice president of marketing and research for Marcus & Millichap Real Estate Investment Brokerage Co. in San Francisco, sees strength in the office and multifamily sectors but says retail and hospitality are also performing very well.

A survey from Cushman & Wakefield indicates that sales of commercial property in San Francisco from January through June totaled $305 million, on par with the $316 million in sales recorded for the same period a year ago. But with nearly $200 million of sales in escrow in August, the total figure for 1996 will undoubtedly exceed last year's total of $536 million.

"There is upside potential for rents and, in our opinion, it's a good time to be a buyer," Sandell says.

"Property owners and investors who held on through hard times are certainly not ready to depart just when the market gets hot," Nadji says.

Office space filling up

Midyear reports from half a dozen brokerages show the San Francisco office vacancy rate declining steadily. Most posted an overall rate of 10% to 11% in January.

As an example of how rapidly space is filling, the 223,000 sq. ft. 160 Spear St. went from 20% to 85% occupied in one month, with just two leases.

Several companies signed for more than 100,000 sq. ft. Others are looking for that much. Virtually all represent expansion rather than relocation for lower rent as in the recent past.

Trying to find lower rates now would be futile anyway. Rents have risen 10% since January and continue upward, according to New York-based Julien J. Studley Inc.

Studley estimates rents will have to rise above $30 per sq. ft. to justify new building, but at the rate they have been climbing, it won't take long to reach critical mass.

Nadji compares the situation to that of the mid-'80s when spiraling demand and strict development controls conspired to drive rents into the high $30 per sq. ft. range. "Back then, companies took a lot of risk in committing to space. Tenants today are more conservative in estimating their needs," he says.

Helping strengthen the market, Nadji says, is a tightening in suburban markets, leaving tenants with fewer options.

Several large transactions occurred over the last 12 months, with insurance companies and pension funds accounting for the majority of purchases. Prices for well-leased and well-located Class-A buildings have been running $160 to $170 per sq. ft., though buildings with vacancies have sold as low as $100 per sq. ft.

Class-B sales have been slower, but Peter Van Meter, first vice president of Los Angeles-based CB Commercial Real Estate Group, says that will likely change as tenants shut out of the Class-A market start driving Class B rents up.

Conversions help industrial market

The San Francisco industrial market has become an adjunct of other markets as older industrial loft buildings and ware houses are converted to office, residential and retail uses. The transformation is a boon for sellers, particularly in the popular South-of-Market area, or SoMa. The area began to upgrade in the '80s with an influx of restaurants, bars and clubs turning SoMa into a popular nightlife zone.

Rental demand is growing, according to David Becker, a broker with Ritchie Commercial Real Estate in San Francisco. Tenants are paying industrial rents of $0.50 to $0.75 per sq. ft., then investing in upgrades that bring their costs to the equivalent of $1.50 per sq. ft. and more.

According to Nadji, activity is brisk for buildings selling in the $2 million to $5 million range. Prices range anywhere from $20 to $60 per sq. ft., depending largely on what it would take to make them suitable for today's users.

Retail expands at a quick pace

The Union Square retail district continues to both attract major new retailers and foster expansion by existing ones. Polo, Armani, Ann Taylor, Saks Fifth Avenue, Macy's and Eddie Bauer all have expanded or will soon. Nike Town, Jil Sander and Ultimo are set to open this year.

Downtown retail space is in short supply, according to retail broker Nick Toussaint of Toussaint & Associates, San Francisco, though more space is coming. Federated Department Stores will lease out 70,000 sq. ft. of the former I. Magnin building.

A complex by WDG Cos. of San Francisco, Millennium Partners of New York and Sony Corp. atop Moscone Convention Center will provide 350,000 sq. ft. of space, though Sony will use all but a small fraction for its own entertainment concepts. However, WDG and Millennium want to include four floors of retail in an office building proposed nearby.

Taiwan-based Pacific Resources bought the 558,000 sq. ft. Pacific Center, with plans to convert 110,000 sq. ft. to retail. The need for expensive seismic work held the price to $19.75 million.

Annual rents range from $24 per sq. ft. at the fringes to $350 per sq. ft. on Union Square proper, according to most brokers.

Union Square investment prices are very strong, according to Van Meter. "It's a market that really doesn't vary that much, with cap rates of 7%, 8% and 9%," he says.

Several major retail property sales occurred this year, with a high of $627 per sq. ft. paid by Atlanta-based Jamestown for a 59,000 sq. ft. retail complex. Saks paid $13.9 million for a 37,400 sq. ft. office building to expand its men's store. An $11 million renovation will bring the total investment to $665 per sq. ft.

Brokers report large-format retailers want space in the city, but there are few suitable sites. New construction is extremely limited. Conversion of other property types is the primary source of new space.

Hospitality rates moving up

Chip Conley, president of Joie de Vivre Hotels in San Francisco, says hotel revenues in San Francisco are up 14% from a year ago, with occupancy averaging 76%. An upsurge in business and tourist travel has brought improvement across the board.

According to Bob Eaton, vice president of Colliers International Hotel Realty in San Francisco, the market has come back very strong from a decline that began in 1988. "San Francisco is basically fully recovered from the diminished values of the past several years. We're beginning to see very strong movement in rates," he says, estimating rates at top tier hotels have increased 10% to about $130 per night.

No projects are in development and few are contemplated. In a best-case scenario, says Eaton, 1,000 first-class rooms would be added to the current inventory of 30.000 rooms in the coming two to three years, mostly in small projects. Pacific Resources proposes to include a 200-room luxury hotel in its Pacific Center redevelopment, while Federated has mentioned a small hotel as part of its tentative Bloomingdale's proposal.

In San Francisco, Marcus & Millichap brokered the sale of the 150-room Powell Hotel across from the cable car turnaround for $6.9 million to an investment group. Upgrades are planned. Joie de Vivre bought the 94-room Orchard Hotel in late '95 for $6.29 million and spent $800,000 to transform it into the Hotel Rex.

Multifamily ranks high

The Koll National Real Estate Index rated the San Francisco market second in the nation for investment value. According to M/PF Research Inc. in Dallas, the vacancy rate is 1.4% and average rents are $1,303. Rents have climbed approximately 10% in 12 months, according to figures from the city.

As Nadji says, "The very high cost of homebuying by default will continue to support a strong pool of renters."

While nonprofit developers accounted for more than 50% of new construction in San Francisco in 1995, low-income housing tax credits are providing a significant incentive to for-profit developers to enter this segment of the market, according to the local office of consultants Novogradac Fortenbach & Co.

Most market-rate development in San Francisco involves projects with six to 20 units, largely due to the difficulty of assembling large parcels of land. Embarcadero Pacific of San Francisco, for example, paid $4.5 million for a SoMa warehouse and will spend $11.5 million to convert it to 60 residential lofts.

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