Kim-Mai Cutler Crunch Network Contributor
Kim-Mai Cutler is a writer focusing on public policy and the technology industry. She is also working on a new global communal living project called Roam .
How to join the network Justin Bedecarre Crunch Network Contributor
Justin Bedecarre is the co-founder and chief executive of the real estate brokerage HelloOffice and 42Floors .
How to join the network One of my favorite things to do is to riff on Bay Area real estate and tech — of all kinds, residential, commercial, retail … And Justin Bedecarre has been working with San Francisco founders for almost a decade in the commercial real estate market. He’s now a founder of HelloOffice, a technology-powered commercial real estate brokerage. We talk about what 2017 holds for the office market.
Q: Tell me what you do.
Our whole goal is to make looking for office space smarter and faster. We’ve replaced all the PDFs, spreadsheets, and paperwork. We have a platform to collaborate with our clients and manage the entire deal from start to signing. We also come from the world of startups and real estate brokerage. We have both pedigrees. We’ve walked in our clients’ shoes. The storylines we’ve experienced personally are really relevant.
Q: What’s an example?
Let’s say you’re a company that’s just raised a $20 million Series B and you need 20,000 square feet and you’re moving on up from 5,000 square feet. You need space that can house 200 people that you’re either going to outgrow or never fill and sublease in the next 18 to 24 months.
In this market, you’re looking at five-year leasing deals that probably cost $1.5 million a year. If you are not profitable and need to raise another round to fulfill the entire lease, you may spend up to $1 million just in security deposit.
You’ve just committed to spending $10 million. You’ve just wiped out half your round on a lease!
Q: That’s crazy.
So if you can figure out ways that companies won’t need to do that — and that’s what we’re able to do through looking for two-year subleases, plug-and-play and fully furnished spaces — the cost savings are crazy.
Q: Why does the market still do five-year deals even those are obviously a poor fit for the life-cycle of tech companies?
The chips are stacked against startups. Most startups don’t want to do these deals. At this stage, it doesn’t make sense unless there is a really unique opportunity. But the industry is built around longer term deals.
For the landlords, turnover costs money and downtime, especially if they have to invest money in building out the space. Construction costs have skyrocketed since Title 24 went into effect , which can add an extra $25 per square foot to a build out.
For brokers, we are incentivized to do longer term deals. Like I said, the chips are stacked up against startups when it comes to leasing office space, not to mention that rents are really high right now, and so landlords want to lock in those rents. The whole industry is based on longer-term leases. Five years, by the way, is not that long. New York leases are often 10 years. SF landlords look at seven years as a long term.
Buildings are bought and sold on expected lease terms of that size — coupled with the fact that it’s the top of the market.
Photo: Getty Images/Mitchell Funk/Photographer’s Choice
Q: How do you know we’re at the top of the market and what should founders do to plan around that?
First of all, rents have plateaued and have stayed that way for most of 2016. The high was the third quarter of 2015 and average rents are $72 per square foot across the city.
I think, however, that with all of these stats, everything deserves context. If you’re east of 4th street, you’re looking at $72 to $76 rents. If you’re west of 4th street, you’re looking at $60 to $62 rents. Then down on 9th street, you have companies like Planet Labs , Code For America and Thumbtack , which have beautiful spaces at much cheaper rates. A lot of these companies got locked into longer leases in 2015, because tenants had a lot less leverage then.
But we’re also seeing close to 3 million square feet of subleased space. Subleasing is the big story of 2016. We’re going to set a record for more subleased space than at any other year in the city’s history.
Q: What does that mean?
The most important story of 2016 has been subleasing. If you look only at the number of subleases that come to market, it’s easy to use that as a negative indicator of the overall market and economy. People are thinking, “Companies are downsizing — the market must be turning!” But that is only part of the picture. You have to also look at whether those subleases get leased by other companies.
Not every company is going to work. Just like with talent, the reason the Bay Area talent pool is so strong is that there are other places to go if a company doesn’t work out. It’s the same thing for office space. The subleased space that is going on the market is getting filled, if you look at the whole picture.
So if you’re thinking about doing a Series B round, and you’re looking at a five-year lease that sends $10 million out the door, there are two ways of dealing with that.
You can warehouse space, take down 25,000 to 35,000 square feet and sublease 20,000 to grow into later. That can work, but it’s risky. Or you can plan to leave in two to three years with the mentality that this is not going to be that much money and you can find a subtenant to fill it.
Some founders are thinking that $10 million is worth a lot more to them now than it will be later, especially because many companies aren’t profitable. If you could spend $3 million on sub-leasing with a plug-and-play space, that’s an extra $7 million you’ll have to spend on talent.
I’d say with most companies we see, they need another round of financing to fulfill the lease obligation. So there’s a huge amount of pressure from everywhere as the board expands and as companies have to hire.
Q: If we’re at or near or past the top of the market, what happens when the office market weakens? Like what happened last time after the dot-com bust?
People were doing deals in the $120 to 130 a square foot range back then. Companies were doing long-term deals for spaces they never occupied with zero revenue.
We talk about this a lot. It is different this time. Something is going to happen, but it’s not going to be all of these companies failing simultaneously because they didn’t have legitimate business models.
That will be the case with some. A lot of our clients are not profitable but they have a path towards it, and a lot of the same landlords are still around and they’re not doing the deals they did in 2000. This is not that. This is not the dot-com era.