San Francisco, home to a growing technology sector, is attracting investor interest. Stephanie Schwartz-Driver explores ‘Silicon Beach'
This time around, the tech boom is changing the real estate landscape of San Francisco, as rapid growth in the sector encourages urban redevelopment tailored to creative industries.
Economic recovery from the last crisis began around 2009 in the San Francisco/Silicon Valley region, and since then employment in San Francisco's technology sector has grown at a faster rate than Silicon Valley's. At the start of this year, employment in San Francisco's tech sector was up 10%, compared with a 3% rise in the San Jose/Silicon Valley area, according to data from the California Employment Development Department.
Today's economic growth profile is different from what was seen after the dot.com boom in the late 1990s, when firms flocked to the Silicon Valley area around San Jose, including Mountain View, where Google has its headquarters; Cupertino, worldwide headquarters of Apple; and Palo Alto, home to Stanford University and Hewlett Packard's headquarters. During the recovery following the dot.com crash, growth was again focused in that area. This time, however, San Francisco is a major beneficiary, with start-ups locating in the city and big tech firms establishing offices there, resulting in a dramatic demand for real estate.
"San Francisco is a very strong market and extremely active," says Colin Yasukochi, director, research and analysis, at CBRE. "Pricing levels have already eclipsed those of 2007, the previous market peak."
What is particularly telling about this growth cycle is that "rents for creative, tech buildings are rivalling class-A CBD office space", according to Julia Georgules, research manager at Jones Lang LaSalle. In 2007, growth in San Francisco was focused on class-A CBD properties. This time, creative space is the priority - low-rise, horizontal, collaborative workspace with larger footprints, styled with exposed brick or timber, and, hopefully, built with sustainability in mind.
It is not only the type of space that is different - it is also location. "Tech firms do not like the sterile CBD environment, although they enjoy the amenities," says Yasukochi. San Francisco's CBD, known as the financial district, is home to financial and business services firms. Wells Fargo is still the biggest presence, but the traditional service firms, such as accountancy and law firms, have diminished in size compared with their pre-crisis levels. Even there rental rates are up, vacancy rates are down, but demand is not as strong as it is in other parts of the city that are attracting the new tech firms.
San Francisco had a fairly large cluster of tech firms before the last boom, most located in the ‘South of Market' district. Today, vacancy rates in South of Market are as low as 4% and there is very little opportunity. As a result, tech firms and the real estate developers seeking to attract them have broadened out.
‘Mid-Market' is the new hot area. Developers have been actively regenerating this once desolate neighbourhood for two years now. Firms like Twitter, Yelp, and Airbnb have located in the area, and others, including Pinterest and Quora, are rumoured to be looking around. Dolby recently bought the 385,000 sqft 1275 Market Street, with plans to renovate the buildings. Although rents have risen by more than 50% since 2010, they are still significantly cheaper than in Silicon Valley - by as much as 25% - and the city has implemented some incentives for firms relocating. In Mid-Market there is a payroll tax exemption for new job creation, and the city administration is known to be very friendly towards tech companies.
Over the past two years, the neighbourhood has changed from a run-down area to a dynamic one, incorporating major business tenants as well as a growing number of amenities, including banks, cafes and restaurants, and high-end groceries. Georgules believes that this is going to have a lasting impact on the city. "There are a handful of renovation projects that would not have happened if it had not been for this current economic boom," she said.
Interestingly, a few services firms, including venture capital firm Benchmark Capital, have recently taken space in Mid-Market, and other venture capital firms have been looking. Financial firms have traditionally favoured CBD locations, but proximity to the tech activity may have been an incentive. This business sector has generally been quieter than it was in the previous boom.
"During the last boom, there were a lot of beneficiaries, including service providers like advertising agencies and financial companies. This is not happening to the same extent," pointed out Yasukochi, who noted that tech companies are also more conservative with their spending this time around.
Most of the new tenants attracted to San Francisco have been either start-ups or companies moving in from elsewhere in the region, particularly suburban markets and Silicon Valley. The young workers that the tech firms want to attract prefer to live in urban centres like San Francisco; Silicon Valley, once the hub of the industry, is largely suburban. San Francisco is also easily accessible to the rest of the Bay Area.
Despite the growing workforce, decreasing vacancy rates and rising rents for apartment rentals and booming residential sales, there has been little residential development in the city. New development is focused on offices, without residential or retail components.
Office investment activity is by no means restricted to emerging districts. A number of class-A trophy buildings are turning over in San Francisco at the moment. On the market are several premier trophy buildings, including 101 California Streets, with 1.2m sqft, One Montgomery Tower, and 333 Bush Street, which, interestingly includes 13 floors of residential condominiums.
Foreign investors have been vying with domestic buyers for sound properties, and the city is expected to record up to $5bn (€3.97bn)in office property sales this year. The market is very competitive, said Yasukochi, who noted that "some of the highest prices have been paid by foreign investors". Some have paid above replacement cost, betting that the market is going to continue to rise. "Whether they are overpaying remains to be seen," he said.
To stay in the race, Georgules noted, some class-A building landlords are renovating their traditional office space to be more attractive to tech tenants. Landlords are also finding that other kinds of tenants, not just tech firms, are interested in open collaborative workspaces.