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New Faith In San Francisco Real Estate And City Hall Emerging Despite Capital Markets Shutdown

The heavy fog over San Francisco’s commercial real estate market may be slowly dissipating.

The cautiously optimistic CRE community knows structural headwinds like inflation and its large remote workforce are still challenges to overcome. But in the words of Prado Group President and CEO Dan Safier, “It’s a good time to be investing right now, given how far things have fallen.” 

Farella Braun + Martel's Brent Saldana, Strada Investment Group's Kathryn Hofstetter, Related Cos. California's Gino Canori, Prado Group's Dan Safier and Kidder Mathews' David Nelson

Safier was one of several CRE professionals to sound notes of hope about San Francisco’s office and multifamily real estate markets at Bisnow’s San Francisco State of the Market event this week at the Grand Hyatt in downtown San Francisco

Well-located, Class-A San Francisco office towers present “a tremendous buying opportunity,” said Gino Canori, president of the Related Cos.’ California office. 

Bisnow reported in April that office values hit bottom at the end of 2023 and are trending upward.

Office landlords are still offering concessions and tenant improvement allowances in light of the city’s 35% vacancy rate. But leasing momentum has started to pick up, Kidder Mathews Northern California and Nevada President David Nelson said. 

The majority of leasing activity is for subleases and renewals, he said.

The Presidio, Jackson Square and the Financial District have emerged as office submarkets to watch, panelists said. 

A hotbed of activity for tech firms and startups, the Presidio “has virtually no vacancy,” Safier said.

Recent data compiled by The San Francisco Standard supports Safier’s observations. The federally managed Presidio Trust operates about 2M SF of commercial space in the Presidio, near the national park bearing the same name, with an occupancy rate of 97%. 

The corridor around the Transamerica Pyramid redevelopment in the Financial District also has limited vacancy.  

“We are seeing pockets of strength, but you have to be selective,” Safier said. “It needs to be walkable, safe and clean.”

Yet while leasing has gained momentum, stubbornly high interest rates have shut down virtually all San Francisco property sales involving equity. 

“I’ve never seen anything like it, and I worked in commercial real estate in the ’90s,” said Arden Hearing, executive general manager of development for Lendlease’s West region. “The capital markets are just not looking at San Francisco right now.” 

Allen Matkins' Tim Kelly, Lendlease's Arden Hearing, CoBuild Construction's Ed Wood, MGAC's Cynthia NeSmith-Montanez, Willdan's John Bringenberg, Grosvenor's Steve Buster and Sares Regis' Dave Hopkins

In fact, Australia-based Lendlease divested from its U.S. holdings, a topic mentioned during the event. In late May, the firm announced the sale of Hayes Point Tower, a 47-story office building under construction in the Civic Center district, for $1.2B.  

As for San Francisco’s multifamily market, tenant demand is strengthening after an exodus from California following pandemic-era lockdowns.

“With the talk of everyone leaving San Francisco and moving to Miami, somehow the city absorbed 6,000 multifamily units, according to CoStar,” Force Development Partners Chief Investment Officer Chris Fraley said. “I have this theory that within the next 12 to 18 months, we are going to hit a huge pop in rental growth.” 

Apartment values are approaching $400 per SF, similar to 2013 values, Nelson said. Even though few deals are getting done, cap rates average about 6%.

Safier said that Prado is “back in acquiring mode” for existing multifamily and mixed-use assets, but his firm is highly selective in where it invests.

​​Panelists reversed course from their typical hail of criticism for city government, instead indicating their relationships with Mayor London Breed's administration have improved.  

Since taking office, Breed has launched a handful of initiatives to speed up the development process. In March, San Francisco voters approved Proposition C, which makes it easier to convert office buildings into residential projects. The new law removes the city’s transfer tax on office buildings purchased for residential conversion, saving buyers up to 6% of their purchase price.

Voters also approved Proposition A last March, enabling the city to issue $300M in bonds to develop and maintain affordable housing

“We have worked hand in glove with the San Francisco mayor’s office, and they’ve gotten a lot better — and I have been in this market for 40 years,” said Cynthia Nesmith-Montanez, senior director of the Northern California office of consulting firm MGAC.

Novateur Capital's Maxim Shapiro, MJD Capital Partners' Marie Murphy and Forge Development Partners' Chris Fraley

In February 2023, the state of California approved San Francisco’s new housing plan calling for the creation of more than 82,000 rental homes. This more than triples the city’s long-term annual housing production average, according to Gov. Gavin Newsom’s office. 

Only about 1,800 new housing units were authorized by the city last year, based on estimates from the city's planning department, The San Francisco Standard reported last December. That is about 1,000 fewer units than in 2022 and the fewest the city has approved in 14 years.

Department spokeswoman Anne Yalon attributed these scarce production numbers to the same concerns Bisnow panelists raised: high interest rates and rising construction costs.

Instead of being deterred by these structural headwinds, panelists offered some potential solutions.

Developing more prefabricated office build-outs for tenants is one cost-saving and efficient strategy Castro Valley-based CoBuild Construction Services is eyeing, President Ed Wood said. 

Mass timber projects with concrete frames would also speed up development timelines, produce less greenhouse gas emissions and reduce overall costs, NeSmith-Montanez said.

“We can’t do the same things we have always done as an industry,” Wood said, adding that it is time for the construction industry “to innovate and adapt.” 

But innovating and adapting certainly won’t happen overnight.

“This is a problem that's going to take at least a couple of years,” Canori said.  

Kennedy Wilson Property Services' Marty Smith interviews San Francisco City & County Chief Economist Ted Egan.

Persuading workers to return to the office remains a challenge, but it is getting better, Canori said. Venture capital firms increased their investment in the Bay Area in 2023 compared to the previous year, and employers will always have a strong pool of highly skilled labor in the region.

“The talent is still coming here, and it will continue to come here. They're not creating a Stanford University anywhere else in this country,” Canori said. 

Canori said a defensive strategy could very well result in big property returns in the next 48 to 60 months.

“For companies that own and operate assets right now, it's going to be tough going,” he said. “You've got to protect, defend, asset manage and stay close to your assets.”