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SAN FRANCISCO-The metro area office market continued an impressive recovery in the third quarter with just over one million sf of net absorption that dropped overall citywide vacancy 80 basis points to 16.5%, according to the latest market report from Cushman & Wakefield. Class A vacancy fared even better, dropping 150 basis points to 16.3%.

With nearly 1.9 million sf of net absorption registered year-to-date, the office market is on pace to eclipse two million sf of net absorption for the first time since 2000, according to the report. Just over half of the YTD net absorption is due to tenants moving in from outside the city. A big chunk of the total came this past quarter when LucasArts moved its 700,000-sf headquarters from Marin into the newly constructed Letterman Digital Arts Center in the Presidio. For the year, in-migration has accounted for 945,539 sf of net absorption, or 50.3% of the YTD total.

The South of Market CBD apparently will be the first to see vacancy dip back into single digits. In the third quarter, overall SOMA CBD vacancy fell 140 basis points to 10.4% while class A SOMA CBD vacancy fell 220 basis points to a tidy 10.0%. In the North of Market CBD, overall vacancy rose 80 basis points to 14.0% while class A NOMA CBD vacancy rose 80 basis points to 14.2%.

By far the most significant drop in vacancy during the third quarter occurred in the non-CBD SOMA area, where vacancy has been the highest. Overall non-CBD SOMA vacancy fell 420 basis points to 24.5%, while vacancy in class A suburban SOMA space fell 790 basis points to 26.2%. Overall non-CBD vacancy fell 90 basis points to 20.1%.

If job growth picks up, C&W thinks it’s possible that the overall vacancy could hit single digits by the end of 2007. “This scenario seemed extremely unlikely just two years ago when the city was grappling with nearly 16 million sf of vacant space, but now seems possible given San Francisco’s surging momentum,” concludes the report.

The drop in vacancy has spurred rental rate increases, particularly in the upper end of the market, according to the report. Direct CBD asking rents were up across the board in the quarter and have been on the rise all year. Since the end of the third quarter 2004, class A direct asking rents have increased $2.64 to $33.12 per sf–and the more you drill down, the better it gets. Direct rents in the city’s newest class A space jumped $4.42 to $41.09 per sf over the same 12-month period, and view space in the city’s newest class A space has shot up by $9.72 to $53.82 per sf, according to the report.

Suburban rents, meanwhile, are on the decline. In the past three months, class A direct asking rents in the suburban SOMA area fell $0.84 to $20.76. Direct asking rents for all classes in the suburban SOMA area fell $0.20 to $20.64 during the same three-month period, and direct asking rents for all non-CBD space fell $0.48 to $22.56.

The San Francisco CBD’s rapid improvement has kept the investment market white hot. Demand continues to far outweigh supply, driving cap rates to unusually low marks and enabling some investors to flip assets in less than 36 months for a sizeable profit. The Karasick Group is in contract to sell the Bank of America Center at 555 California for $1.05 billion just 15 months after it accumulated ownership of the 1.8-million-sf development for about $875 million. If completed, it would market the first billion-dollar sale since the Embarcadero Center sold for $1.22 billion in 1998.

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