Hot Market for Offices Kept Up in 1st Quarter

San Francisco offices spaces are selling at premiums, but office rents are not yet keeping pace.

By Ryan Tate
San Francisco Business Times

The first quarter brought the most fevered trading yet in what was already a heated market for Bay Area office buildings, industry players said, underscoring expectations that rents will continue to grow quickly.

Amid the rapid dealmaking, five San Francisco buildings traded for more than $80 million and the San Francisco portfolio sold for $2.7 billion. Many purchase prices were not justified by existing rents but instead reflected speculation that rents will continue to grow at 10 percent to 20 percent per year as the local economy heats up.

The activity within San Francisco showed signs of spreading outside the city borders, helping to drive for example the $400 million sale of the Watergate Office Towers in Emeryville to Hines REIT Inc. The thinking is that as San Francisco fills up and gets more expensive, companies will lease more space in the inner East Bay.

“There is a lot of regional and international capital chasing deals in this market,” said Jones Lang LaSalle’s Mike Seifer, who in the first quarter brokered the $129 million sale of 180 Montgomery St. in San Francisco.

“Anyone who is buying in San Francisco is buying … to capture significant rental rate growth,” not because they will earn a healthy return on existing leases, Seifer said.

In fact, a significant number of deals are trading with returns below 5 percent per year based on existing rents.

By all accounts, the speculative frenzy is made possible by an abundance of capital from abroad and at home. But the capital is attracted to San Francisco thanks to some encouraging signals about the local economy.

Rent is one of those signals. Class A San Francisco rents rose 21 percent year-over-year to $42 a square foot per year in the first quarter, according to Grubb and Ellis, with north financial district Class A rents even higher at $47 per square foot. Rent for some top view space now runs more than $100 per square foot, per year. ..

Colin Yasukochi, Grubb and Ellis’ director of research, noted in a research report — appropriately titled “Rents, Prices Scream” — that there is a sort of feedback loop in action, with buyers picking up buildings at high prices due to rising rents in the market, then hiking rents in their new buildings in order to justify the prices they paid.

But Yasukochi said in an interview that the rent hikes are also a natural outgrowth of growing leasing, which in turn is driven by job growth in the technology sector and in financial services outside of banking.

Office space in the city’s financial district is now almost 90 percent full, and there relatively little under construction at the moment.

“San Francisco has gained newfound popularity among investors as a market that is roaring upwards,” Yasukochi said.

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