In a concrete tower on San Francisco's Market Street, where employees of Internet companies such as Pets.com once toiled, developers are building the city's latest hot product: apartments.
Tishman Speyer Properties is converting the top half of the 40-story building at 575 Market to housing from offices left vacant in the dot-com bust. "Housing in San Francisco so far has been a very, very strong performer," said Tishman Managing Director Ezra Mersey. "We're confident it makes sense."
Developers that bought or built offices to capitalize on the 1990s Internet boom, when rents more than doubled in less than four years, are seeking refuge in housing. San Francisco office rents have fallen 60% from a peak of $80.16 a square foot two years ago, more than in any other U.S. city, broker Cushman & Wakefield said. About 15 million square feet of space is vacant, equal to all office space in Portland, Ore.
Equity Office Properties Trust, the largest U.S. office building owner, recently said that it ended a two-year venture to build San Francisco offices after investing $253 million only to see vacancies soar. Though costs to retrofit office buildings can limit the payoff on conversions, developers and brokers say the strategy is preferable to losing money on an empty building.
"These people are sitting with an asset saying, 'What should I do about this?' " said Paul Zeger, president of Pacific Marketing Associates in San Francisco.
The transformation of offices into homes will help ease what the Federal Reserve Bank of San Francisco ranks as the nation's tightest housing market, analysts said. Only 14% of residents can afford the median home price, $568,000 in the city.
Nationwide, 58% of residents can pay their local median rate, the California Realtors Assn. said.
Residential rents in San Francisco are higher than in any city except New York, rising 0.5% to an average $1,832 a month in the fourth quarter from the third quarter, apartment research company RealFacts said.
The average U.S. apartment rent fell 0.4% to $905 in the fourth quarter from the previous quarter, according to Reis Inc.
The increase in city apartment rents signals the end of a 6.9% decline in those rents from the year-earlier fourth quarter as companies fired workers, analysts said. No other city is positioned like San Francisco for conversion to housing from offices, analysts and developers say.
"We experienced a more pronounced cycle than anyplace else," said Tom Sullivan, former president of the dissolved Equity Office venture. "There was so much venture capital funding jobs. When the jobs went away, it left us with a high vacancy rate."
San Francisco's office demand is weakest in the 91-block former industrial area known as South of Market, where refurbished brick warehouses hold loft apartments, restaurants and offices. The area lies in the shadow of Tishman Speyer's tower that once served as the headquarters of ChevronTexaco Corp.
The end of the Internet boom left 49% of the area's offices empty. The citywide office vacancy rate climbed to 23% in the fourth quarter of last year from 1.8% in the third quarter of 2000, brokers say.
"It's a ghost town," Robert Larscheid, senior vice president at broker Axiant Group, said of the neighborhood that once was home to Internet retailer Pets.com and data network provider Northpoint Communications Group Inc. "There's no migration at all from the financial district and no new business enterprises."
A.F. Evans Development Co. plans to build 165 apartments in the traditionally industrial area after developer Ron Kaufman scrapped plans for a 300,000-square-foot headquarters for Internet software maker Macromedia Inc.
Evans Development also wants to create 250 apartments at the site of a warehouse once intended for offices, President Charmaine Curtis said.
"Heavy industrial is never going to relocate there and people don't necessarily want it," Curtis said. "A more logical transition is housing and mixed use."
Developer Douglas Rosenberg plans a 110-unit condominium project South of Market, where he once intended to build 110,000 square feet of offices.
"Just about every office developer in San Francisco has considered the residential option," Rosenberg said.
Tishman Speyer, based in New York, plans 130 apartments for the former ChevronTexaco building, where cutbacks by tenants such as Proxicom Inc. left the 40-story tower and a neighboring 20-story office building 87% vacant, property broker Grubb & Ellis said.
Housing costs have been driven up by a lack of supply in a city with 760,000 residents, said John Crapo, a director at the San Francisco Center for Economic Development. "The minimum we should be producing is 3,000 units a year, and we haven't done that in 12 to 14 years," he said.