Tech: Big and Small

For decades the San Francisco office market was a unique and seemingly irreplaceable technology hub.  The city had so many variables essential to startup tech success that companies believed they had to be here, regardless of the cost.  Proximity to Stanford and UC Berkeley, the epicenter of venture capital on Sand Hill Road, the Silicon Valley - - - home to major tech headquarters, including Google, Apple and Facebook and the abundance of bright young tech talent that flocked here from all over the world to be part of the innovation economy.  All this in one place.  It was a compelling narrative (and true).  The city’s beauty and appeal to younger tech workers was obvious.  Like New York City was (and remains) for those seeking their fortune in finance, until fairly recently, if tech was your thing, you had to be in San Francisco. 
 
The first wave of tech occupiers shaping San Francisco and contributing to where we are today was decidedly early stage.  In the 1990s efforts to monetize the internet resulted in a new economy we came to know as the “dotcom” economy.  These were glorious times.  Young technology workers flooded the city seeking their cut of IPO riches.  Then, in 2000, it all came crashing down.  But no matter, there was still gold in them there hills. 
 
Meanwhile the Silicon Valley, traditional domain of tech hardware companies, had steadily diversified its tenant base, attracting a bevy of large headquarters for the likes of Google, Facebook, Apple and more.  Young workers, many of whom lost money and their appetite for the startup world, sought refuge in these large, stable companies.  But in the early 2000s, these companies had no interest in opening offices in San Francisco.  They were “valley” companies.  Yet as the economy continued to grow and competition for labor accelerated, it became clear that having a San Francisco office was critical in the war for talent as it turned out the young talent living in San Francisco wanted to live and work here.  Thus began the second wave, one in which the city enjoyed not just robust startup activity, but surging demand from big tech, as well.
 
The third wave, the period from 2010 to 2020, was the perfect storm.  There simply wasn’t enough office space in San Francisco – you couldn’t build it fast enough.  Startups had seemingly figured out how to avoid the ugliness of being scrutinized in the public market by staying private in perpetuity (thanks to historically cheap and plentiful capital).  These companies would routinely go from 2,000 sf to 100,000 sf in a span of 3 years.  Venture sponsors would push their portfolio companies to grow as fast as possible.  Growth at any cost.  Meanwhile, having long ago established their beachheads in the city, the big tech giants would occasionally rise up and take down space in 300,000 sf+ increments.  We even had home grown startups that made it all the way from small to big in the likes of Salesforce, who dominated the city with its bold strategy for a world class campus totaling millions of square feet, smack in the middle of the CBD.  More than a few massive real estate deals happened solely because one company was convinced another was about to lease a block of space that stood in their path of growth.  This was called “defensive leasing” and it was a developers best friend.  The specter of Google or Facebook leasing up a huge swath of space was a bit like Keyser Soze from the Usual Suspects.  You could never be sure it was real, but it was possible.  And in those times, when hiring was frenetic, having a little extra space was no problem.  Hell, if it turned out you didn’t need it, you could probably make money on it downstream…it’s an asset, after all.
 
This is the story of San Francisco these past 30 years.  Three waves of tech overtaking the market, redefining the city with a growth engine the likes of which few cities have ever seen.  But today it’s different.  We’re in the fourth wave.  We have problems at both ends of the tech demand spectrum.  On the big end, companies are bracing for a recession, freezing new hires; and, in some cases, laying off employees.  When they are hiring, they’re adopting a more distributed approach to labor, looking for higher quality at a lower cost, which often means not in San Francisco.  At the same time, the small end of tech demand spectrum, the startup world, has taken its show on the road.  VC spending is both down overall and, importantly, down in the region.  We have a lot of vacancy – currently 23%, a record high.  We know the coming quarters will bring more vacancy as expiring leases will result in reduced amounts of leased space.  With the San Francisco startup engine turned off and Keyser Soze long since gone, how will the technology sector absorb all this excess space?  Or, will this fourth wave stand as a time when our great city is forced to pivot to a more normalized office market, one in which demand is more diversified, less tech heavy and occupiers have abundant space options?  What would that look like?  For starters, the underlying rental values would be substantially lower and would remain so for a prolonged period of time.  But for limited market segments, when the market has a vacancy factor north of 15%, it’s generally a tenant’s market.  Despite being 2.5 years into the pandemic, the story of the San Francisco office market’s fourth wave is still young.  And just as with the prior three waves, this one will be no less fascinating to experience.