Why Smaller Outfits Struggle in S.F.
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The downside of the Bay Area boom is that small and midsized investors can't compete. Between institutional dollars and tech firms building or buying assets, the fundamentals are stiff. The Heritage Group managing director Rocco Cortese tells Bisnow that despite more than $300M in commercial real estate transactions, only one deal has been done in S.F. Rocco has deep NorCal roots, having co-founded Bay Area-based Presidio Exchange Advisors before Heritage (here in his new San Diego office at 610 W Ash St with orange chairs in honor of the Giants). Heritage has more than doubled its total leasing and managing portfolio since Q4 2013 to 49 properties and 1.75M SF.
The firm has spent years looking in S.F. but to date has only been able to find a deal in Jackson Square where it felt it could get the rents to justify the price. It was a small deal with below-market rents on a lease to a tenant, he says. The lease is expiring in June, and Heritage will be able to renovate the property and double the rents. Before that deal, Rocco says the company looked at others in Jackson Square and in the Financial District. But as an investor, Heritage found Bay Area tenants were able to buy properties well in excess of what it could underwrite because they looked at the real estate differently. For example, the company looked at buying 188 Embarcadero last year, but was eventually outbid by Google, which saw the building in a way an investor doesn't: a place to house people. Rocco says normal valuation paradigms don’t apply in this scenario and Heritage could not be competitive. San Diego-based Heritage also has LA and S.F. offices, and turns 10 this year.
It's still very frothy in the Bay Area, and as an investor, Heritage weighs current rents versus future growth in any deal it looks at. It’s hard to make it work and to compete against institutional investors. That said, Rocco says he's looking for smaller office deals where the rents are below market and where the downside is limited. The same applies to smaller residential deals where there's a value-add play through improvements and proactive management.