SAN FRANCISCO—The San Francisco office market is among the strongest in the country, according to a 3rd Quarter Report from Marcus & Millichap. The insatiable demand from technology firms is driving the market, and if it keeps up, asking rents in the city could overtake Manhattan the end of this year.

Prior to the recession, when Manhattan office space leased for a 50% premium above San Francisco rent the real estate firm says.

Salesforce has been the largest market mover thus far in 2014. The company recently agreed to occupy half of the newly renamed Salesforce Tower when the project is completed in 2017. The 714,000-square foot lease will bring the firm's future commitments in the area of Fremont and Mission to more than 1.5 million square feet. Twitter and Dropbox have also signed significant leases in the first half of this year as firms race to secure large, contiguous blocks of space, which are in short supply. The rapid expansion by cash-rich technology firms has resulted in one of the lowest vacancy rates in the country and will enable operators to aggressively lift rates on available space in the coming year.

The investment market is weighted in the class A and B segments as owners of lower-tier properties await stronger operations before listing their assets. Tight conditions and the recent run-up in rents have pushed most value-add investors out of the market. Those remaining are being creative when considering ways to generate value above appreciation and rent growth. Dilapidated warehouses can be repositioned as creative space, which is favored by many of the incubator technology firms. The costs to convert these buildings are significant, particularly if elevator replacement is involved. However, the new owners can command much higher rents in areas not traditionally recognized as office-using districts. There is a market for stabilized office space as well, especially properties with near-term lease rollovers. Overall, average cap rates for stabilized class B assets are in the low-5% range, depending upon tenant roster and location. Class A office buildings trade at cap rates well below the 5% threshold.

Among the 2014 forecasts included in M&M's report includes the following:

Employment: Hiring activity in San Francisco will remain healthy this year as 29,000 po


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David Phillips

David Phillips is a Chicago-based freelance writer and consultant with more than 20 years experience in business and community news. He also has extensive reporting experience in the food manufacturing industry for national trade publications.