From Alexander Hamilton of Versant Law Group:
A lot of the growth in real estate over the past few years has been fueled by the ongoing tech boom in both in the Bay Area and other parts of the country. According to one recent estimate, tech companies continue to drive the most leasing activity across the country—nearly 25% of all leases over 20,000 square feet in the past two years.
Yet I get asked on a regular basis as to whether I think the tech boom is ending. Even though I continue to see a lot of tech leases, there are 5 reasons I think the tech boom may be ending.
1. National tech employment growth may be falling off. One estimate shows that growth in hiring in the tech sector has dropped by 50% from 2015. While growth in the tech sector continues to grow at twice the average of other private sector industries, the steep drop off from last year is troubling.
2. Increased Focus on Fundamentals. As tech grows up and investment homeruns fade from popular memory, investors are focusing more and more on business fundamentals, favoring companies with profitable track records, firm business plans and solid customer bases. As a result, fewer tech investments are occurring and the ones that do occur are smaller.
3. Venture capital activity in tech firms is slowing. Overall the number of investments made by VCs in tech companies has fallen by 40% from Q2 of 2015 and the total capital invested has dropped by 33% from $12B to $8B. According to PWC, investment in unicorns (companies valued $1B or more) during that same period dropped by only 8%, which means that more capital is flowing to large companies while start-ups struggle for financing.
4. Tech Moving to Less Expensive Markets. With the slowdown in investment in the tech industry, seed and early-stage companies are becoming more sensitive to the cost of real estate. The result is that they are moving into less expensive markets or submarkets. Within San Francisco alone, tech companies are foregoing Soma and instead moving more and more into the Union Square, Jackson Square, North Waterfront, mid-Market and Van Ness Corridor submarkets. Even well-funded, late-stage startups while continuing to grow their real estate footprints, are doing so at a less aggressive rate.
5. Growth in Co-Working Environments. Also as a result of tightening investment markets and uncertain futures, more and more seed and early state companies are foregoing for the time being permanent office space in favor of co-working environments. This not only reflects the fluid work environments and schedules of tech workers but the lack of confidence in investors and management regarding the short and long term futures of early stage start-ups.
What does this mean for commercial real estate? A down turning tech market may be the impetus for a number of changes in the commercial real estate market.
1. Fewer leases to start ups. As investors and landlords become more concerned about the future of tech, we are seeing less leases being entered into with start-up tech companies. In addition, those leases that are being entered into with tech start-ups are on more aggressive terms and with larger security deposits.
2. More leases to Unicorns. With a slow-down in leases to early stage tech companies, more landlords are looking to lease to large tech companies with established credit. These tenants are correspondingly able to negotiate more favorable lease terms.
3. Credit concerns. With the tightening tech market, landlords are having credit concerns not only with early stage tech companies but also with maturing tech companies who may be experiencing limits on their ability to grow their business and may also be seeing increased competition from other maturing tech companies. As a result, landlords are taking a more critical eye to the future prospects for strength in tech performance. As a result, they are seeking greater credit enhancement both at the commencement of tech leases and as tech companies look to extend their leases.
4. Expansion of co-working companies. Finally, the decrease in leasing to start ups and early stage tech companies as well as the hedging of bets by investors, is resulting in a large number of start ups and early stage companies moving into co-working environments such as WeWork, Covo and Next Space. The result is that more companies are moving into the arena of establishing co-working environments as a way of meeting the growing demand for co-working space.
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