This could get very ugly!
Apple shares have plunged 32% from June last year, and $282 billion in shareholder wealth has evaporated, on swooning sales and crummy data from suppliers. Today shares fell briefly below $90 for the first time since June 2014. But still, Apple’s market capitalization is about $507 billion. And Alphabet’s is $498 billion.
Along with Facebook, Amazon, and LinkedIn, they constitute the Big Five in Silicon Valley, with a giant footprint on commercial real estate that continues to grow. So just how exposed is Silicon Valley’s office market to a slowdown among the Big Five?
Already, there are cracks in the foundation. According to the Q1 report by commercial real estate services firm Savills Studley, overall asking rent rose by 7.1% year-over-year, and vacant availability edged down to 7.6%. But deal volume for the past four quarters plunged 14% year-over-year to 7.5 million square feet (msf).
“Overall, this signals a shift to a more subdued market,” the report explained. Yet the big tech companies were still in an “unrelenting pursuit of talent and office properties” despite “growing concern about the challenging conditions for start-ups and a weak IPO market.”
But compared to San Francisco, leasing fundamentals “have not contracted as sharply.” Because in San Francisco, all heck is threatening to break loose.
In Silicon Valley, it comes down to the big tech companies. And that 7.5 msf leased over the past four quarters doesn’t include the slew of purchases by Google, Microsoft, and Facebook.
The red flag in the office market is sublet space. Companies that have big ideas about growth, and that perceive an office shortage, will lease more space than needed and warehouse that space until needed. But when the market turns for them, and they’re under pressure to cut costs, they’ll trim their headcount and put the vacant office space on the sublet market. This supply that materializes overnight creates a glut, and lease rates begin to swoon.
While sublet supply in San Francisco “has soared to its highest mark since 2010,” according to Savills Studley, it’s still more subdued in Silicon Valley. It is being watched nervously, after the beating that startup valuations have been taking, the “down rounds” of funding, the shut-downs, and even bankruptcies.
And there’s a new thing to fret about, according to the report:
Intel’s potential sale of its venture capital business could further exacerbate the devaluation of tech stocks. During 2015, Intel invested $514 million in 143 companies including innovative new security software and wearable device companies. If they unload these investments at a loss it could have a corrosive effect on other investors in the same or similar companies.
That would be the worst-case scenario.
And then there’s the issue of staffing:
Stock devaluations also hurt the ability of newer startups to compete with established tech firms for talent. Until recently startups could dangle equity stakes in front of talent as part of a recruiting package, now prospective employees – much like investors – are likely to focus on the “potential” value of these stakes.
Additionally recruiters specializing in tech sector placement have started to note a slowdown in the quit ratio. Talent is becoming a bit less demanding and less willing to jump to newer companies who offer a big stake in a new enterprise. As one commentator recently said, talent is becoming “wary of boarding a sinking ship.”
But the big tech companies remain aggressive in the real estate scene. Apple is building itself an immense circular palace. And Google is out there grabbing what it can. In December, it signed a 111,443 sf lease for the entirety of 1001 N Shoreline in Mountain View. It agreed to buy NetApp’s eight-building, 600,000-sf campus. And in March Google leased the 280,000 sf at Moffett Towers in Sunnyvale that Motorola, which is slashing its workforce, no longer needs. Motorola will keep just one 40,000 sf floor. Facebook, Apple, and Microsoft have also been on a “buying spree of late.”
So how exposed is Silicon Valley’s commercial real estate market, after the multi-year boom phenomenon, to a downturn at Apple, Google, Facebook, Amazon, and LinkedIn?
Since 2010, the Big Five have leased 14% of all office space coming on the market in Silicon Valley from Mountain View on south, according to data from Newmark, Cornish & Carey, a top commercial real estate firm in the Bay Area. This includes 51% of all new developments completed or still under construction since 2010.
Just five companies leased 51% of all new developments! This is in addition to the buildings and campuses the Big Five built and bought outright.
And there has been a construction boom. According to data from Newmark, Cornish & Carey, as of April, there are about 9.4 msf under construction, including Apple’s 2.8 msf palace. About 74% of the new construction has been preleased.
So what happens when the tech market turns, and when the layoffs spread from smaller companies, and from Motorola and Yahoo and the like to the Big Five, and they dump some of the vast leased space they’re now warehousing for future use on the sublet market?
Everyone here who’s been through this before knows what will happen. Sublease space will skyrocket. It will turn the market upside down. Demand will evaporate overnight. The market will become illiquid. Deal volume will crater. Lease rates will follow. This is always how it happens after such a boom.
“All it takes is a couple of big tech companies folding and the floodgates open, causing the sublease market to blow up, rents to drop, and new construction to grind to a halt,” according to Savills Studley new report on San Francisco. Read… “Market is on Edge”: US Commercial Real Estate Bubble Pops, San Francisco Braces for Brutal Dive
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.