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COMMERCIAL REAL ESTATE

The Big Squeeze in San Francisco's Financial District

Offices: As rents soar and vacancies sag, space is at a premium. Prospective tenants 'stand in line, take a number.'

February 11, 1998|JESUS SANCHEZ | TIMES STAFF WRITER

The crowded confines of San Francisco's Financial District are home to some of the nation's largest banks, influential law firms and prominent brokerage houses.

But even the most mighty of these institutions have been humbled by the power wielded by the neighborhood's new kingpin: the landlord. With vacancy rates hovering below 2%, finding vacant office space in the Financial District is about as tough as spotting a free parking spot.

Annual rents in the most prominent skyscrapers along the most desirable streets--Montgomery, California, Bush--have spiraled above $40, $50 and most recently $60 a square foot. Even at those prices, tenants seeking a prestigious address "stand in line and take a number because there is so little space," said broker Mark McGranahan of Cushman Realty Corp.

The soaring rents and lack of space are the result of a booming economy, with financial giants--such as Wells Fargo and Montgomery Securities--and obscure but rapidly growing multimedia firms leasing everything from gleaming skyscrapers to renovated warehouses. Stringent growth controls and a lack of substantial new construction will make it tough for tenants for several years to come and will spur many to look elsewhere for available space.

"We don't see any new buildings going up," said Parkash Ahuja, head of administration for Charles Schwab, one of the Financial District's largest tenants. "If [space] keeps getting more and more expensive, we just cannot keep adding things in San Francisco."

After hitting bottom during the recession of the early 1990s, San Francisco's commercial real estate market had experienced a steady recovery until last year, when the pace picked up dramatically.

Much of the frenzy has been focused on the Financial District, a compact area tucked into the northeast corner of the city where banks, including Wells Fargo and Bank of America, and other financial services firms have long congregated. In these blocks, rents for Class A buildings, which are often newer structures in desirable locations, jumped 34% last year, according to real estate services firm Whitney Cressman Ltd. The spike in rents was even more dramatic among Class B buildings, often older, renovated structures, which posted an increase of 45%.

The biggest shock has hit tenants whose leases have expired and who must now wrangle with landlords eager to double their rent. Despite the steep increases, many firms have few options if they want to remain in or near the Financial District, said Daniel Cressman, president of Whitney Cressman.

"The bad news is not that you are paying higher rent," he said. "The bad news is you may not get the space you want."

As rents have ballooned, so have property values. Prudential Insurance and the Rockefeller family put four office towers in Embarcadero Center up for sale late last year, and offers have reportedly topped $1 billion. A second round of negotiations has begun after "quite a few initial bids" were made, said Prudential spokesman Rick Matthews.

The tight market has led brokers to sniff out reports of company mergers and relocations that could open up space before it officially goes for lease. When a floor or space does come on the market, it is not uncommon for multiple offers to appear.

"It was like a tight housing market," said real estate attorney Rick Mallory, who recently went through the hunt for an office. "You have to bid over the asking price to get the deal."

Mallory's firm--Allen, Matkins, Leck, Gamble & Mallory LLP--found itself in a bidding battle for pricey space at Embarcadero Center. It lost and the firm ended up in another Financial District building paying about $45 a square foot--roughly double what it pays in downtown Los Angeles.

Despite rising rents and property values, new construction remains nonexistent. The remodeling of former industrial buildings opens up space, but in very small amounts. Developers and their financial backers want to see if the boost in rental rates holds up before making any costly commitments to build major new buildings, say real estate observers.

"We are at the point where it's very close to making sense to build," said broker Mead Boutwell at Cushman. "But I have yet to see any bulldozers pushing dirt."

The dearth of space has forced many buttoned-downed Financial District tenants to venture into the once tawdry and now up-and-coming South of Market district. Here, established professional firms compete with upstart multimedia companies for space in renovated factories and warehouses at rents that exceed those of Los Angeles skyscrapers.

Charles Schwab will be jumping south of Market Street this year when it completes a $30-million renovation of an older, seven-story office building for its expanding brokerage operations. But at Schwab's projected rate of growth, the renovated building's360,000-square-feet of space will be completely filled in about two years. Then what?

The company remains committed to San Francisco but is exploring the possibility of opening satellite offices in other parts of the Bay Area to accommodate future growth, said Ahuja, who oversees the firm's real estate and leasing operations.

"Even if they start building [now], it takes three to four years" to complete a project," Ahuja said. "We have to be concerned."

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Pricey Real Estate

The San Francisco business district is the country's second-highest-priced commercial real estate market after midtown New York City. A comparison of commercial rents in major real estate markets in the fourth quarter of 1997:

City: Average rent per square foot in business district

Midtown New York: $39.29

San Francisco: $38.04

Boston: $37.49

Washington: $35.43

San Jose: $30.48

Fairfield County, Conn.: $28.98

West Palm Beach, Fla.: $28.38

Orange County: $26.52

Bellevue, Wash.: $26.12

Chicago: $25.34

Los Angeles: $20.28

Source: Cushman & Wakefield

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