San Francisco office-building sales may exceed $5.3 billion this year, the most since the market peaked in 2007, amid a technology-fueled rent surge that shows no signs of slowing.
Twenty-two downtown office properties changed hands through July 20, three deals were pending, and 10 buildings and two land parcels were listed and drawing robust investor interest, according to brokerage CBRE Group Inc. The average purchase price has risen to $465 a square foot, the highest since 2007, when it was $516 a square foot on $8.6 billion of sales, CBRE data show.
San Francisco and the adjacent Silicon Valley are "arguably the two strongest" U.S. office markets, research firm Green Street Advisors Inc. said in a July 24 report. Citywide office rents jumped 28 percent in the second quarter from a year earlier as Internet firms Airbnb Inc., Twitter Inc. and Yelp Inc. (YELP) signed new leases, according to CBRE.
"It's pretty easy to see why prices are escalating so quickly with a tech boom going on," Dan Fasulo, managing director at property research firm Real Capital Analytics Inc., said in a telephone interview. "It's a phenomenon taking place nowhere else."
Office rents may rise a further 25 percent over the next two years as tenant demand continues and supply remains tight, Kenneth Rosen, an economist at the University of California, Berkeley, said in an interview. More than half of the 2.6 million square feet (242,000 square meters) of new office space set to open by 2014 is already leased, brokerage Cassidy Turley estimates.
San Francisco's "red-hot" market has lured U.S. pensions, closely held funds, real estate investment trusts and overseas buyers seeking perceived safe havens for their money, according to the Green Street report. Even with yields at 5 percent or lower, money is flowing to the city's commercial property because benchmark 10-year U.S. Treasury notes have sunk below 1.5 percent, said Jed Reagan, an analyst at the Newport Beach, California-based firm.
"International and domestic capital is looking to invest in gateway cities, and San Francisco qualifies in spades," Richard Pink, managing director at New York-based real estate investor Clarion Partners, said in an interview. "It's got a tech industry that is strong and broad, and a quality of life that compares with anywhere in the world."
Clarion bought two San Francisco office buildings last month on behalf of pension clients, paying $180 million, or $502 a square foot, for 600 California St. in the financial district, and $147 million, or $603 a square foot, for 475 Brannan St. in the South of Market area, according to Pink.
The biggest prize now on the market is 101 California St., a 1.25 million-square-foot cylindrical office tower that may fetch as much as $1 billion, based on the highest recent per- square-foot prices, said Russell Ingrum, San Francisco-based vice chairman of CBRE's capital group.
Nippon Life Insurance Co.'s 92.4 percent interest is up for sale through a U.S. real estate unit, according to marketing materials from listing broker Eastdil Secured LLC. The 48-story tower, developed by Houston-based Hines and designed by architect Philip Johnson, is 92 percent leased and offers a central location and "breathtaking" views, Eastdil said.
The high-rise is the city's second-largest office building, behind Vornado Realty Trust (VNO)'s 555 California St., according to CBRE. Tenants include Bank of America Corp., with 122,000 square feet; Morgan Stanley, with 100,000 square feet; and Deutsche Bank AG, with 75,000 square feet.
"It's iconic, truly special and unique," Ingrum said.
Hines will retain its 7.6 percent stake and manage the building, according to Eastdil. James Buie, Hines' chief executive officer for the western region, didn't return calls seeking comment. Darwin Rodriguez, an Eastdil vice president, and Greg Berardi, a spokesman in San Francisco for Osaka, Japan- based Nippon Life, declined to comment.
"The obvious candidates for 101 California are banks or insurance companies that would team up in a syndication," said Fasulo. "Capital is looking for returns, and you can't get it with U.S. bonds."
Hamburg-based Union Investment Real Estate GmbH paid $446.5 million, or about $802 a square foot, for 555 Mission St. in May, the top price this year, according to CBRE.
The city's price record was set in June 2007 with Morgan Stanley (MS)'s purchase of the One Market complex, part of a portfolio acquisition from Blackstone Group LP (BX), for $953 a square foot, CBRE said. The deal was financed largely by commercial mortgage-backed securities.
The only U.S. submarket that compares to San Francisco is New York's midtown south, the area roughly between 34th and Canal streets that's popular with technology and media companies, Fasulo said. Recent deals there include SL Green Realty Corp. (SLG)'s agreement in May to buy 304 Park Ave. South for $135 million, or $628 a square foot, CBRE data show.
Across the U.S., office buildings in major cities had the biggest price gain of any real estate sector, rising 8.1 percent in May from February, according to Moody's/RCA Commercial Property Price Index.
Investing in San Francisco isn't without risk. Tech firms make up as much as two-thirds of the city's tenant demand, and buyers late to the cycle will be most vulnerable to a slowdown in a market known for booms and busts, said Reagan of Green Street. The 2001 dot-com collapse was followed by a 60 percent rent plunge, he said.
"San Francisco is the most volatile market in the country," Reagan said. "These investment strategies do raise some concerns, with the city so dependent on tech."
Recent office sales already value 101 California St. above the cost of replacing the building, usually an alarm signal, said Rosen, the University of California economist. Construction of a building in the financial district would be about $700 a square foot, said Pink of Clarion Partners.
San Francisco added 3,800 professional-service positions in June, a fourfold increase over the average monthly gain, while tech employment rose to the highest level since 2000, according to California's Employment Development Department. The office vacancy rate in the second quarter fell to 9.7 percent citywide, and to 4.3 percent in South of Market, CBRE data show.
The regional economy, home to global trendsetters such as Apple Inc. (AAPL), Google Inc. and Twitter, propels innovation worldwide and is "unique in the world," said Frank Fudem, a San Francisco-based partner at Cassidy Turley.
Investors who recall the dot-com implosion and 2008 financial crisis know what they're getting into, and are assessing real estate with care, said Ingrum of CBRE.
"Today, people are much more rational and clear-eyed about risk," he said. "The cost of money is so low that you can pay more and still get the same return."