To be perfectly honest with you, most of the families are going outside of the city and the real answer to the best place really depends on exactly what you are looking for.
If staying in San Francisco is what is most important to you, I would say that Merced Heights would be your best bet. It's not the most exciting part of town, but its close to all the major conveniences and is affordable enough where younger families can enter the market. There have been a few single family homes in the neighborhood that have sold for the low 500's...plus you get a yard. Some younger families are moving to Bayview because there is a belief that the neighborhood is on its way up. However, the neighborhood is still dangerous and will take some time for this process to happen.
One thing that is really important for me to know, is what type of neighborhood and cultural aspects you are looking for. I know that you said that you lived in Los Gatos, and if you like the younger, professional type area, Campbell might be a great fit. The downtown area of Campbell has really blown up, but yet you can still find homes in great neighborhood for 700k probably even less in the upcoming months. You are right smack dab in the middle of all the shopping of San Jose, plus close to Santa Cruz.
Another area where you can really find deals is in Concord and Walnut Creek. There are a lot of families moving to that area because you can get more for your money and yet be extremely close to public transportation (BART). Downtown Walnut Creek is extremely active with nightlife and shopping during the day and there are tons of families that are out and about. The great thing about Concord is that its right next to downtown Walnut Creek, plus the subprime mortgage mess is leading to lots of great deals. Realistically, if you are patient and can find the right deal you will probably be able to get a nice 3bd/2ba home their for around 500k.
Anyways, this is just the tip of the iceberg. If you could tell me a little bit more about yourself and your situation, I can give you some more in depth answers and some recent sales histories.