Soaring San Francisco ‘Skyline’ Rents Still Draw Investors, Tenants

Houston, Transwestern Develpment Company, San Francisco Bay Area, West Coast, Orange, Seattle, Panattoni Development Company, Inland Empire, Los Angeles

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By Neil Gonzales

Commercial office rents continue to rise due to the booming Bay Area economy, but that’s not preventing tenants, particularly in the technology sector, from still seeking out the priciest office spaces in San Francisco. And the strong rent growth in Class A and “trophy” properties is drawing investors from here and abroad.

Competition is fierce among those targeting luxury office spaces in key urban centers across the country, with San Francisco posting the highest rent growth over the past 12 months at 9.6 percent among major cities cited in a new report from Chicago-based commercial real-estate services firm JLL (Jones Lang LaSalle).

Indeed, those high-end offices in San Francisco saw a whopping 80.7 percent growth in rents—a figure more than four times the next fastest growing market—over a 36-month period, according to JLL’s Spring 2014 U.S. Skyline Review. The report dubbed these offices as “Skyline” properties, which consist of Trophy, A+ and Class A urban centers and are known for their exceptional assets, low vacancy, market-leading rents and strong demand from institutional investors.

In San Francisco particularly, the taller the building is, the higher the rent. Investors and tech tenants don’t mind the steep price at all because skyline office spaces offer the best views in the city and excellent amenities such as full-time security and state-of-the-art building systems.

The city’s “trophy” or most premium offices such as the 52-story skyscraper at 555 California St. are fetching rents up to about $100 per square foot annually, according to Julia Georgules, Northern California research manager for JLL. In comparison, typical Class A offices—which are about 20 stories on average—are seeing rents between $45 and $60.

“San Francisco has been a top market investment in the last four years nationally and internationally,” Georgules said. “The economic recovery here has been faster than the rest of the U.S. Office vacancy is declining, rents are going up and the tech sector continues to expand, hire people and look for space.”

It’s well documented that Google, Twitter and other leading technology firms are flooding San Francisco’s office landscape and have become the main driver in the surging local economy. But even more-traditional companies such as Macy’s are basing their technology or online divisions in the city where they can also tap into the high-caliber talent pool, economic growth and active urban lifestyle, Georgules said.

Overall, she said, commercial rents in San Francisco are projected to increase 7 to 10 percent this year.

“Landlords are in great shape for the next year or two,” said Markus Shayeb, senior vice president of tenant advisory in the San Francisco office of Houston-based real-estate services firm Transwestern.

The high rate of transactions or development involving properties of 100,000 square feet or more in recent years just indicates the heavy investor interest and activity in the market, Shayeb said. “I’ve never seen it like this. Before, you would see two to three big transactions a year. Now it seems it’s once or more a month.”

Just several months ago, “we were talking about 3.5 million square feet coming into the market” as relief to the demand pressures from companies wanting space in the city, he said, but those properties now probably won’t be available because they’re going to be pre-leased.

“We’ve witnessed a number of significant trades of skyline assets in the last 12-18 months,” Michel Seifer, a managing director of JLL’s Capital Markets Group, said in a news release. “However, with asset pricing for prime, Class A office properties approaching or in some cases exceeding replacement cost, the emerging trend is the return of major skyline developments, especially in SoMa and locations with close proximity to the Transbay Terminal development area.”

In fact, San Francisco is one of three markets along with Houston and New York that dominate most of the new skyline office development currently occurring in the country, Seifer said.

But while the big technology firms are able to absorb the high cost of doing business in San Francisco, others are starting to look at other options. “The strong demand is forcing some companies outside the city,” Shayeb said, citing the financial services firm Charles Schwab as a prime example.

Earlier this year, Charles Schwab announced plans to relocate a number of its San Francisco-based jobs out of state over the next few years.

Other companies are also realizing there’s “no reason to pay a premium in San Francisco when many of their employees live elsewhere” such as the East Bay, Shayeb said.

San Francisco is close to the “pain threshold” where a market correction will happen, he added. “The current economic expansion in San Francisco has been going on for five years now. From a historical perspective, that’s a long run. It’ll be hard to sustain.”

Then again, he doesn’t see it imploding any time soon. Rather, “there’ll be a gradual leveling off,” he said.

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