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Do Tech Unicorns Pose a Threat to San Francisco’s Office Market?

Do Tech Unicorns Pose a Threat to San Francisco’s Office Market?

Any investor that claims an industry is only going to continue growing today is quickly reminded of both the subprime mortgage crisis and the bubble of 10 years ago. So while the nation’s current top bubble candidate—the frothy technology sector—doesn’t seem to be cooling, office market specialists continue to view the San Francisco Bay area with caution.

Due to strong growth in the technology industry, San Francisco dominated the U.S. office market in 2015, with the city’s vacancy rate dropping to 8 percent and rents surging 129 percent in the past six years to more than $70 per sq. ft. The city is the major draw for venture capitalists looking for tech start-ups, and new firms, not able to get into the prime Silicon Valley locations, flocked to San Francisco’s downtown. Along the way, they contributed to the growth of a walkable, vibrant city that has attracted educated Millennials by the thousands. However, the market correction experienced during the most recent recession is still fresh on the commercial real estate industry’s mind.

That fear is making real estate professionals be on the lookout for certain signs of strain, according to a recent study of the San Francisco Bay area by the commercial real estate services firm CBRE. Tech firms are the major mover in the market, accounting for 36 percent of office stock and 60 percent of all leasing in 2015. The study also reports an alarming growth in the number of tech firms known as “unicorns,” which are firms valued at $1 billion or more that are preparing for initial public offerings. Of the 144 known unicorn firms in the U.S., 60 of are based in the Bay area, with 40 taking up almost 5 percent of the total office occupancy in San Francisco, according to the report. Even more alarming is the slowdown of IPO capital in the past two quarters—money the start-ups rely on to survive.

Still, even though the study shows an alarming reliance on start-up firms that need venture capital, there’s not much cause for concern right now, says Colin Yasukochi, CBRE’s director of research and analysis in the Bay area.

“Even if we lost all the unicorn firms, that would only be a 5 percent increase in vacancy, and the demand is such that it would be recovered rather quickly,” he notes. “It’s true that there can’t be a market that has no cycle, but technology has become so integrated with everything we do, that if a few firms fail, there will still be companies hiring here.”

The bubble talk is premature, according to Matt Hart, senior managing director at real estate services firm Savills Studley in San Francisco. There is demand from all sectors, not just technology firms, and even the latter companies are being more careful this time around, he notes. “I was here during the days, those days were pretty crazy,” he says. “The start-ups today are being more cautious with their real estate.”

The established tech companies are being more efficient with the space they take and and sub-lease the excess square footage, according to Hart. Not only does this provide an additional income stream for the firms, it also gives start-ups a foot in the door. The rents are about the same as those obtained through direct leases, but not having to pay the build-out costs in today’s market can be a game-changer, Hart says.

“It’s not the rent, it’s the capital costs of opening an office, the cost of construction has skyrocketed,” he notes. “The subleasing helps because then the start-up doesn’t have to put so much into the real estate. The only future problem is, will the demand still be there when the sublease term runs out, or will the main tech tenant be left holding the bag?”

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