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Tale of two West Coast cities

  • 31Mar 16
  • Property Multi-manager

It’s hard to miss the coastal redwoods in the San Francisco Bay Area. They look as if they might touch the sky. Likewise, real estate prices in the Bay Area are soaring to unprecedented heights. For technology companies, staying on the forefront of innovation means having to actively grow their operations. This growth has had a direct impact on the real estate markets in some west coast locations including Silicon Valley, San Francisco, and Seattle.

Technology companies are expanding in all three of these markets, taking up more space as they continue to hire top level talent. This growth is driving demand in the local office and apartment sectors and has resulted in declining vacancy and escalating rents. 

Silicon Valley is the headquarters for some of the most prominent companies in the technology sector including Google*, Apple* and Facebook*.  Instead of occupying traditional office space, many of the top technology companies in Silicon Valley are building out large corporate campuses, which take up a significant amount of real estate. Right now, Google and Apple own or occupy more space in Silicon Valley than all of the combined tech sector office space in San Francisco.

Silicon Valley also has a high concentration of rising entrepreneurs, venture capital and private equity firms who fund these startups and tech companies. Competition among these groups vying for office space in Silicon Valley has caused rents to rapidly increase. Sand Hill Road in Menlo Park and Hamilton Avenue in downtown Palo Alto, both in Silicon Valley, are currently the two most expensive office streets in America.

Most companies located in Silicon Valley are competing to hire and retain the top talent. While the small startups may offer employees equity in the company as an additional benefit, the more established companies offer lavish amenities, which explain the large office space requirements for their campuses. The amenities provided can include outdoor social spaces, on-site child care, spa treatments, laundry, and healthcare services.

The demographics of the talent that technology companies target are primarily millennials in their 20s and 30s who prefer urban living. Many of these millennials are willing to go to great lengths to have the best of both worlds, living in trendy and urban San Francisco and working for a company with a great reputation in suburban Silicon Valley. While many believe it is worth it, this lifestyle demands a lot of time and money.

The migration of technology talent to the urban core is driving apartment rents to peak levels. San Francisco is now the most expensive residential market in the U.S. The average rate for a one bedroom apartment across the city is $3,200 per month, while the newest one bedroom apartments cost around $4,500 per month.

In addition to the high apartment rents, the commute from San Francisco to Silicon Valley can be up to two hours each way. To ease the travel pains, many top companies in Silicon Valley will provide their employees with free transportation on luxury buses equipped with Wi-Fi, allowing them to stay plugged in and work throughout their commute.

Residents who do not want to deal with the long commute are looking to find jobs in San Francisco. As such, a growing number of technology firms are opening offices in the city. These include Salesforce*, Twitter* and smaller startups trying to make their mark. Technology companies signed approximately 55% of new San Francisco office leases in 2015, which surpassed the peak tech leasing activity during the dot-com boom in 2001. That level of new leasing is especially impressive because the technology sector recently accounted for approximately 10% of the city’s total jobs.

Similar to Silicon Valley, demand for office space is also driving up rents in San Francisco. As a result, more traditional office tenants who want to maintain a presence in the city, such as law firms, banks, and service providers, are managing costs by reducing their office footprint.  

The soaring prices across the Bay Area are causing some companies and residents to consider cheaper alternatives. One option is relocating to Seattle.

The soaring prices across the Bay Area are causing some companies and residents to consider cheaper alternatives.

In 2000, Seattle was predominantly known in the technology world as the headquarters of Microsoft*. Later, Amazon* consolidated their headquarters to Seattle’s South Lake Union submarket in 2007.

These two companies are the pillars of Seattle’s position as one of the top U.S. tech hubs and are attracting other technology companies to open offices in the city. Recently, Apple, Google, Salesforce, and Twitter have opened Seattle offices to test whether or not the city might be a reasonably priced answer to future expansion plans.

As new technology jobs open in Seattle, top-level talent is relocating to the city, which has caused apartment rents to rise 54% over the past five years.  Average one-bedroom apartments now rent for $2,100 per month, which is high for Seattle standards, but still well below San Francisco levels.

The promising outlook for growth in Seattle has spurred development activity in the city. New apartment completions in 2014 were at the highest level in the past 25 years, adding about 9.5% of existing inventory to the market. So far, demand has continued to outpace supply.

This leads us to the deciding question: what is next? As office and apartment rents have already increased across all three markets, many forecasters are wondering: can rents, driven by tech sector growth, continue to rise to higher levels over the near term?

In Silicon Valley, the current tech boom is being driven by companies that already have a successful track record and are profitable, like Apple and Google. While expensive, it appears the real estate market is stable because these companies can afford it.

Meanwhile in San Francisco, technology companies such as Salesforce and Twitter are driving growth but have a less clear path when it comes to sustained profitability. Although many of these companies are in growth mode, hiring more employees and taking up new space, if one fails there could be a ripple effect on the local real estate market.

Lastly, Seattle’s real estate prices are in-line with similar-sized U.S. cities. Its market feels stable, similar to Silicon Valley’s, because of Amazon’s and Microsoft’s stronghold.

The present story of the Bay Area and Seattle real estate markets is one of encouraging growth and positive outlooks. Managing realistic expectations for growth and understanding supply and demand fundamentals in each market will be the key to identifying the best investment opportunities going forward.

*Companies mentioned for illustrative purposes only and should not be taken as a recommendation to buy or sell any security. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.

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