News Clipping S.F. space race: Commercial real estate scarce By Sam Diaz [[email protected]]
Mercury News [www.sjmercury.com]
July 30, 2000

THE South of Market area in San Francisco has long had a reputation as a creative Mecca, thanks to the artists, architects and designers who once dominated the neighborhood’s warehouse and loft spaces.

But these days, you need creativity simply to find any office space in the popular downtown district, also known as SoMa.

Commercial real estate in San Francisco, much like residential housing, is nearly impossible to find.

Legions of companies want a San Francisco address on their business cards, believing it adds a certain cachet that’s attractive not only to clients but also to prospective employees, especially young, high-tech workers.

“I live in San Francisco and want to work in San Francisco,” said Alex Edelstein, 31, who is trying desperately to find office space for the 14—and soon-to-be 20—people working for his Internet start-up company, Viralon Corp. “I started to hire a San Francisco-centric employee base, people from the East Bay, people from the city, people who ride BART. I want to be a San Francisco businessman.”

People in search of office space are doing whatever they can to get into—or stay in—the city.

They’re talking to friends and acquaintances who might have extra room in their own leased buildings. They’re dipping into venture capital dollars to win bidding wars with other prospective tenants or slashing other expenses to offset rising rents. They’re settling for unattractive space and looking in seedier neighborhoods.

And some are even taking the financial plunge and buying their own “fixer-upper” buildings—with plans to offset renovation costs and the hefty mortgage by leasing extra space to those in need.

It’s all because of low vacancy rates and the fundamental laws of supply and demand.

The vacancy rate for office space in downtown San Francisco is less than 1 percent—0.78 percent to be exact, according to the Co-Star Group, a Washington, D.C.-based real estate research firm. That’s down from almost 2 percent at the end of June and more than 6 percent on June 30, 1999.

By comparison, downtown Los Angeles has an office vacancy rate of more than 17 percent and midtown Manhattan, 3 percent.

Near $100 a square foot

Rents for high-end San Francisco office space—the bayfront properties that overlook the bridges and offer dazzling views—are nearing $100 annually per square foot. The lesser stuff—the mid-range office buildings with no views, no janitorial services, no maintenance crew and no utilities included—is running $50 to $60 per square foot annually.

At $60 a square foot, the monthly rent equates to $25,000 per month for a 5,000-square-foot space—enough space for 20 to 25 employees. At $100, the same office would run more than $41,000 per month.

Even at those prices, the buildings will find a tenant.

“For rents to change significantly, there needs to be a lot more space built or a lot fewer people working in that space,” said Mitch Kemp, a broker with Pacific Commercial Leasing in San Francisco. “The rents remain tight. It’s the same thing with housing. It really is a very simple system.”

Optimistic insiders are hinting that the rental rates that began skyrocketing late last year are finally starting to level off.

But others, like entrepreneur Edelstein, aren’t convinced. His staff is housed temporarily in a converted loft on Potrero Hill, near Pacific Bell Park. While his employees keep busy working toward a launch later this year, Edelstein searches for their permanent home.

So far, his quest looks hopeless.

“Some of these buildings are real pieces of junk,” he said. “There are buildings without good parking, without nice interiors. And forget about views. We don’t have any views in anything we’re looking at.”

Extras such as views, parking and janitorial services don’t come often in San Francisco’s mid-range commercial market.

There’s no view in the old photo studio near Sixth and Folsom Streets, the one that Seattle-based mylackey.com leased in anticipation of a Bay Area debut later this year. Mylackey.com is responsible for the taxes, insurance, utilities and janitorial service.

However, the 5,500-square-foot space does have conference rooms, high-speed Internet lines and a modern motif with new flooring and a spiral staircase. And it’s available—for $62 annually per square foot, or $28,400 per month.

Executives at mylackey.com, a personal errand service, have decided against using the San Francisco space for their local offices, opting instead for a spot in South San Francisco because of its proximity to the airport and its easier drive to Silicon Valley cities.

Markus Shayeb, a broker with HC&M Commercial Properties, is confident that the space will be leased. He says almost anything will be leased these days, even office space in neighborhoods known for drug trafficking and problems with the homeless.

“Sixth and Market is historically one of the worst areas in the city,” Shayeb said. “It’s a horrible area that’s coming alive with old buildings being renovated. But with the vacancy rate, people are looking at that.”

The city or bust

Edelstein isn’t quite there yet, but he is determined to find a place in San Francisco. It’s that important to him—and his employees, the mostly young and single dot-commers who prefer to live and play in the city.

Edelstein has considered other Silicon Valley addresses but “I’m really kind of holding out right now. It’s kind of a cultural thing with San Francisco. A lot of people who founded this place like San Francisco.”

Besides, it’s hardly any easier to find office space in the valley. The Sunnyvale-Cupertino area has a vacancy rate of 0.14 percent, Mountain View-Los Altos is at 0.49 percent and Palo Alto is at 0.19 percent.

And the rents in Palo Alto are running as high as $120 per square foot annually for full-service property, according to Redwood City broker Don Reed. That’s about 20 percent more than the most expensive space in San Francisco.

A rent increase was enough to send Chris Hempel, co-founder of Spark Public Relations firm in Palo Alto, in search of new digs.

She longed to be in the valley, close to her clients and the center of the high-tech community, but she couldn’t find anything in her price range.

She then looked at San Francisco but found rents there to be more than she wanted to pay.

That’s when she and husband Hugh decided to make the investment in a building of their own, and they started looking for something affordable in San Francisco.

“What else could we do?” she asked. “We just started running numbers and it made more sense to purchase.”

It was hard, she said. Some brokers laughed, saying there was nothing available for less than $3 million.

Eventually, they found a place—about 6,000 square feet of warehouse space near 9th and Bryant streets, just off the Central Freeway—for about $1.8 million.

She admits that it needs work—paint on the outside, a gutting on the inside, new lights and new fixtures. Still, it offers plenty of room for her needs—and probably some extra room for someone else who needs a place to set up shop until she’s ready for an expansion.

And the monthly payment goes toward owning the place, not rent. “I just couldn’t fathom sinking that kind of money down the drain every month,” she said.

Still, her building won’t offer the same kind of amenities that a spot in San Francisco’s Hills Plaza building, located along the waterfront near Folsom and Spear streets, would offer.

Amenities come at a price

Commercial real estate broker Dan Mihalovich is looking for someone to lease 69,000 square feet of office space on two floors in that building. The windows and balconies overlook the Embarcadero, the bay and Treasure Island and offer a towering vista of the Bay Bridge. A fountain bubbles in the plaza outside, where workers spend their lunch hours. A BART station and the ferry building are within a few blocks. And the new Muni F line, which runs along Market Street and the Embarcadero out to Fisherman’s Wharf, stops just outside.

But all of this doesn’t come cheap. The rent is one of the highest in the city—about $100 per square foot or more than $575,000 monthly.

Mihalovich said companies are continuing to start up or expand in San Francisco, no matter what the cost. “We’ve experienced a record level of leasing activity,” Mihalovich said. “Companies are well-funded.”

In fact, it’s becoming just as attractive—if not more—to be located in San Francisco instead of Palo Alto, Sunnyvale or Menlo Park.

“In the old days, it was Page Mill Road, but now, when you’re looking at multimedia and start-ups, San Francisco looks good on a business card,” Shayeb said. “It’s certainly better than Walnut Creek or Pleasanton.”

© 2000 Mercury Center.

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