May 11 (Bloomberg) -- Frank Fudem, a San Francisco broker for office tenants, realized that rents in the city were about to spike as Twitter Inc. agreed to move to a gritty neighborhood and leasing by technology companies started to accelerate.
“Twitter was and is the whole phenomenon,” said Fudem, a partner at real estate services firm Cassidy Turley. “I tell clients to make their deal as soon as they can.”
Twitter’s relocation next month to Mid-Market, an area better known until now for drug deals, graffiti and vagrants, has sent rents up as much as 60 percent in a business district that didn’t exist a year ago. That type of growth is making San Francisco the best U.S. office market as demand from Internet and social-media companies surges.
The city’s five-year investment outlook, based on rent-growth forecasts, beats West Los Angeles, Boston and midtown Manhattan, its closest competitors, according to Green Street Advisors Inc. Office occupancy in the first quarter surpassed the pre-recession peak in 2007, at almost 75 million square feet (7 million square meters), data from Cassidy Turley show. Annual effective rents in the metropolitan area rose 6.8 percent, the biggest gain in the U.S., Reis Inc. reported last month.
“It’s an outright boom,” said Kenneth Rosen, chairman of the University of California’s Fisher Center for Real Estate and Urban Economics in Berkeley. The economist, who advises U.S. banks and real estate investment trusts on market trends, said hiring at social-media and other Internet companies accelerated office-rent gains he thought would occur in 2013.
Pensions, REITs and foreign funds seeking to buy U.S. commercial property can expect values to keep rising because rental rates are still well below the previous peak, said Joe Rodriguez, managing director at Invesco Real Estate, which oversees $48.9 billion of property investments. The Dallas-based company since August has purchased two office-retail buildings in the Union Square shopping district, for $51 million and $30 million, according to Real Capital Analytics Inc.
“It’s worth noting that during the dot-com boom, office rents approached $70 a square foot on average,” Rodriguez wrote in an e-mail, referring to San Francisco’s late 1990s run-up, which collapsed in 2000. “Tech and creative company demand is healthy, and there is a robust venture capital and IPO market for companies that happen to reside in the Bay Area.”
Rents Up 24%
San Francisco office rents rose 24 percent to an average $46.66 a square foot in the first quarter from a year earlier, and are up 39 percent from the market bottom in 2010, according to Jones Lang LaSalle Inc., which tracks rates within city limits. In the South of Market district, a popular location for tech companies and Twitter’s current home, the vacancy rate shrank by more than half in the first quarter to 3.8 percent, the lowest since 2000, the brokerage said.
Yelp Inc., the website that allows people to comment on businesses and services, said yesterday it will relocate its headquarters to a historic South of Market tower that’s being renovated. The annual rent on an eight-year lease for 98,144 square feet begins Oct. 1, 2013, at $54 a square foot and concludes at $66 a square foot, the company said in a filing with the U.S. Securities and Exchange Commission.
Boston Properties Inc., the biggest U.S. office REIT, and closely held Tishman Speyer Properties LP, owner of New York’s Rockefeller Center, describe San Francisco as their top-performing market. Rents rose 15 percent last year at Boston Properties’ Embarcadero Center complex and recent lease deals were completed at rates of more than $70 a square foot, Douglas Linde, president of the Boston-based company, said on a May 2 earnings conference call.
Limits to Gains
Tishman Speyer, based in New York, will start work on two Class A offices in San Francisco and expects annual rent gains in the “high single digits” when leasing begins in 2014, Co-Chief Executive Officer Rob Speyer said in an interview.
The market may not be as robust as it seems, said David Churton, Twitter’s broker at Jones Lang LaSalle. Most tenant leases, at 7,000 to 10,000 square feet, are smaller than high-profile deals, and technology allows companies to produce more with fewer people and less space, Churton said at a March real estate conference. Macroeconomic disruption in China or Europe might have a negative effect on local growth, he said.
“What if tech falters?” Churton said. “We’re not at peak conditions, but we need to be cautious.”
The boom hasn’t been limited to offices, said Steven Brown, senior portfolio manager at Kansas City, Missouri-based American Century Investments. REITs that own apartments in the San Francisco area will see rents advance as much as 13 percent this year, while revenue per available room at hotel REITs will rise 15 percent. Both will double the U.S. average, Brown said.
“It’s the strongest region in the country, and we’re still in the early innings,” Brown said in an interview.
One of the biggest areas for growth is Mid-Market, a forlorn stretch of the city’s main corridor where Twitter, the global messaging service with 140 million active users, is scheduled to move on June 1. The company’s presence will transform the area into a “legitimate submarket,” said Fudem, the Cassidy Turley broker.
The district resisted efforts by public officials, arts groups and property developers to improve it over the years, said Cathy Simon, an architect who didn’t mind the area’s grittiness while working there from 2000 to 2009.
“You had to step over people or somebody’s vomit in the morning,” Simon, a principal at Perkins + Will and designer of the Ferry Building offices and food market, said of her Mid-Market years. “It was an unsavory place, not part of sanitized San Francisco.”
Twitter chose an empty furniture mart as its new headquarters after negotiating a six-year payroll tax exclusion supported by San Francisco Mayor Edwin M. Lee as a way to keep growing firms in the city and build up Mid-Market. The benefit applies to any company that relocates to the district, roughly defined as Market Street between Sixth and Tenth streets, said Christine Falvey, the mayor’s spokeswoman.
Twitter had to consider all options as it experienced “staggering” growth, including moving out of the city, said Ron Conway, founder of San Francisco-based venture firm SV Angel, an investor in the company.
The search overlapped with locally based Shorenstein Properties LP’s acquisition in March 2011 of the old mart for $120 million. As recently as 2007, barbed wire was strung on parts of the property, which includes a 1930s main building and 1970s annex spanning Market Street from Ninth to Tenth streets, to thwart graffiti vandals.
The purchase was made before Twitter agreed in May to be a tenant, said CEO Douglas Shorenstein. His firm will spend a total of $300 million on Market Square, as the 1.1 million-square-foot property is now called. An expanded lobby with 17-foot ceilings, six high-speed elevators, a retail area spanning the width of the building, a courtyard, loggia and basketball court are among the improvements, Shorenstein said during a tour of the site.
The combination of a well-regarded developer, whose investors include Yale University’s endowment, and the marquee tech company produced a “ripple effect,” Lee said in an interview. It revived a 749-unit apartment project, now under construction across Tenth Street, and led to two purchases in late 2011 of nearby office buildings that together have 1.4 million square feet, he said.
“That was significant and reverberated across the real estate community,” Lee said.
Market Square Leases
Twitter’s six-year lease at Market Square gives the company three floors with 215,000 square feet at an average annual rental rate of $30 a square foot. In February, call center company Callsocket.com committed to 29,000 square feet in the building at $42 a square foot. Onekingslane.com, a home-decor sales website, followed in March, renting 52,000 square feet at $44 a square foot.
Yammer.com, a social network for businesses, last month signed the most recent lease, taking 79,000 square feet at $48 a square foot, or 60 percent more than Twitter.
Rates in a nearby office property purchased in the wake of Twitter’s announced move will range from the high $30s to the low $50s a square foot, said Stuart Shiff, CEO of DivcoWest Inc., which bought the building in a joint venture with TMG Inc. The closely held San Francisco firms paid $44 million in October for the 385,000-square-foot property, according to New York-based Real Capital. It is scheduled to open in the first quarter of 2013, Shiff said.
‘Head and Shoulders’
For landlords, the city’s market should outperform for at least the next four years, according to Green Street Advisors. San Francisco office properties are forecast to gain 7.9 percent in annual revenue per square foot through 2016, “head and shoulders” ahead of 6.6 percent for West Los Angeles, 6.3 percent for Boston and 5.7 percent for midtown Manhattan, said Jed Reagan, an analyst at the Newport Beach, California-based real estate research company.
“The concentration of tech in San Francisco is driving it as a whole,” Reagan said in an interview. “From our perspective, it’s the hottest market in the country.”
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