What San Francisco Real Estate Tells Us About This Technology Boom

Real estate can tell you a lot about people and markets.

Hundreds of Web-savvy startups have sprung up in San Francisco’s oldest buildings in the South of Market district (called “SOMA” for shorthand). So behind that sleek new Apple iPhone whatever-it-does application are a bunch of software developers crowded into a brick building that 100 years ago housed a meat warehouse, a button factory, or maybe a flophouse. Best of all (for those who enjoy irony), that same startup labored, even spent a few grand, to make sure their former warehouse looks nothing like: an office.

Original bricks are a must, according to Hugh Scott and Travis James who help run the technology practice at real estate firm Jones Lang LaSalle. “The funkier the better,” says Scott. This duo have spent the past decade landing homes for startups in the Bay area.

 

Exposed pipes are another top request. These used to be out of cheap necessity, in buildings where landlords were too stingy to shell out for even ceilings. But now tenants are willing to payfor what used to be done out of thrift. Scott and James have seen several tenants add $15 to $20 a square foot to their costs of moving in by asking that the ceilings be ripped out and the pipes cleaned to get that cheap chic look. For landlords, ceiling-free space is commanding a 10-20% premium.

One highly sought-after space was previously the storage closet for the nightclub below. What’s hipper than having your startup next to a night club? (Hint: the answer rhymes with “hip club”.)

Dogs are another a must-have accessory for today’s startups. This request tends to rule out any buildings owned by real estate investment trusts, which typically put “no pets” clauses in contracts.

Commercial rents in most cities are below 2007 levels. Meanwhile SOMA is commanding a hefty premium. Rents have jumped 35% just in the last two years, with some deals hovering around $50 per square foot — matching rates in Palo Alto’s most desired corridors, including the famous Sand Hill Road.

“Most spaces are seeing upwards of four offers,” says James, before smiling suddenly as a text message comes in and he adds: “We submitted an offer sheet for a place last Wednesday. Heard back yesterday, and now I’m hearing we’ve got just 24 hours to make a decision.” James sprints back and forth between downtown San Francisco and Palo Alto, alternatively finessing newly-picky landlords and networking with venture capitalists in the hopes meeting up and coming startups.

While rents here are soaring, they’re still not near the last bubble’s levels. That could mean this is less of a bubble, or simply reflect new buildings that have sprung up in SOMA. Scott and James aren’t sure. Another intriguing difference this time around: rents might be a leading indicator instead of lagging when it comes to the performance of tech’s all-encompassing NASDAQ stock index. Take a look (rent rates provided by Jones Lang LaSalle):

 

In the 1999 technology craze, rents trailed gains in the technology index. It’s as if the initial public offerings were happening before startups could even secure space. Then it seems once-optimistic companies got stuck in longer-term leases for a while. The rise and fall of both was swift.

Now it seems the opposite is at work. Rents have been creeping upward as technology stocks have stumbled.

Surely the slow, faltering IPO market is in part to blame. The NASDAQ isn’t yet seeing much action from what’s bubbling in SOMA (Zynga’s lackluster offering is one exception). Last time around the ultimate prize was the IPO. Ten years and Sarbanes Oxley later, IPOs aren’t as desirable or necessary.

Some companies, notably Facebook, Dropbox, and Airbnb, have so far managed to avoid the headaches of going public while still raising IPO-size amounts, from venture capitalists. Social networking tool company Jive landed $120 million in its December IPO. Dropbox meanwhile scored twice that, $250 million, in its private funding round months earlier. If there is froth this time, it isn’t showing up in the NASDAQ.

 

 

Landlords are once burned, twice shy from the last bubble-bust cycle. Most are refusing equity if it’s offered, and demanding big security deposits. Negotiations that used to take three weeks are happening in days, as other potential tenants are banging at the doors hoping a deal falls through.

Some highly-desirable properties, such as the building Twitter has plans to move from, have changed hands without even hitting the market. This building is thought to have especially special mojo. The prior tenant, social networking site Bebo, sold to AOL for $850 million in 2008. (Bebo later was a bit of a fire-sale item, going to a private equity shop for $10 million.) Rumor has the space now going to a gaming company.

One swiftly-growing startup, Web security firm CloudFlare, found their building’s main elevator too corporate-feeling. Instead, they’ve redirected visitors to the old and previously unused freight elevator. CloudFlare commissioned three graffiti artists to come into the building at 1 a.m. to create a dramatic elephant mouth that opens and closes as the doors up and shut.

If this is all sounding a bit self-indulgent and bubblicious, Eric Frenkiel of in-memory database startup MemSQL explains it this way: “Our office is a recruiting tool. We can’t offer better work life balance, so the pitch is that this will be a great place to work and live.” MemSQL’s other co-founder, Nikita Shamgunov, takes this quite literally. The company is currently housed in a SOMA loft apartment, and Shamgunov lives on the top landing, six feet from a rack of servers.

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