News Clipping Changing spaces—Recent sales bring new players to S.F. commercial property
Dan Levy [[email protected]]
San Francisco Chronicle [www.sfgate.com]
August 12, 2005

At the beginning of 2004, real estate titans Shorenstein Co. and Equity Office Properties were clearly the dominant commercial landlords in San Francisco, controlling a combined 11 million square feet in the city.

Then the selling spree began.

The companies have unloaded nearly 6 million square feet between them in the last two years, contributing to record commercial property sales in the central business district and opening the door to a flood of new building owners.

So far this year, about $2 billion worth of San Francisco office buildings has changed hands, following $2.7 billion worth of buildings sold in 2004, according to market research by Grubb & Ellis.

Today, the new owners include private real estate funds, pension funds, foreign companies and Pacific Gold Equities, the New York group headed by syndicators Mark Karasick and David Werner that is seeking to sell the landmark Bank of America Center only a year after buying it.

“Real estate is perceived to be a good place to make money because the alternatives are not as attractive,” said Terry Fancher, who runs Stockbridge Fund, a real estate investment group in San Mateo that owns China Basin Landing in the city. “People who allocate capital, whether it’s from individuals or pension funds or REITs (real estate investment trusts), believe they can get a good return on it.”

That’s the constant refrain from investors: The perception of a safe yield and uncertainty about the stock market, not to mention the low cost of borrowing, are driving real estate acquisitions.

Ironically, the commercial sales frenzy in San Francisco has occurred despite rents that are at the kind of levels they were at 20 years ago. At an average of $31 per square foot for Class A space, commercial rents are nearly two-thirds lower than they were during the height of the tech boom at the beginning of the decade.

“We’ve had a divorce between the underlying market conditions and capital flows,” said Dan O’Connor, managing director of Global Real Analytics in San Francisco. “I’m not saying I agree with the prices being paid for buildings, but I think there’s a bet being made that the (rental) market will continue to improve.

“This is far from a local phenomenon,” O’Connor added. “Real estate has been an investment of choice on a global level.”

To some local real estate experts, however, the gap between rents and building prices in San Francisco is a reminder of the frothy days of the dot- com stock bubble.

“It really is a dot-commish environment,” said Dan Mihalovich, a tenant broker who runs a Web site called The Space Place (www.thespaceplace.net). “An opportunistic owner of the Bank of America building (Pacific Gold Equities) is trying to flip it for a profit. What more evidence would you like regarding the speculative nature of acquisitions these days?”

Yet the selling continues with no end in sight. Indeed, Grubb & Ellis expects to see a new sales record for this year.

Part of the reason, developers say, is that buying existing office buildings, even partially empty buildings, costs less than putting up new ones.

The cost of new construction in the city is about $450 per square foot, far higher than the average San Francisco sales price last year of $309 per square foot. The BofA complex, by comparison, went for $444 per square foot last year when it was acquired in phases by Pacific Gold Equities in a series of highly leveraged deals.

The record in the city is $501 per square foot paid by a Utah state pension fund for 500 Howard St., one of two buildings in the Foundry Square development south of the Transbay Terminal.

Apart from the issue of high replacement costs, many buyers see an upside to the empty space left over from the dot-com bust. Hines, the city’s new top office landlord as measured by square footage, has just purchased a six- building portfolio from Equity Office Properties that included two South of Market office buildings with vacancy rates of 30 and 41 percent.

“The whole strategy is to buy when rents are low and beginning to increase, so you can benefit from the rise,” said Paul Paradis, Hines senior vice president in San Francisco, in reference to its SoMa purchases at 301 Howard St. and 405 Howard St., the other building at Foundry Square. “We don’t think we paid a high price because we’re probably in for half of what it costs for a new building. It seems like a very good deal to us.”

Hines hasn’t done anything radical to attain the top spot. The company, which now has 3.41 million square feet of office space in the city, developed the 101 California high-rise and several other Financial District buildings in the 1980s and 1990s before switching to an acquisition mode in the current environment.

But while Shorenstein and Equity Office Properties have been ferocious net sellers in the last two years—unloading 4 million square feet and 1.8 million square feet, respectively, in the city—Hines has increased its net holdings in the city by only 260,000 square feet.

This means that while Hines is still in the acquisition mode, it doesn’t have too much exposure to the wide divergence between buildings’ sales prices and rents.

“Nobody really knows how rents will increase in the next up cycle, and using historical data can be dangerous,” Paradis said. “But when it picks up, it picks up fast. We have lumpy cycles in Bay Area real estate. It’s not gradual. It’s either up or down.”

©2005 San Francisco Chronicle

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