After years of phenomenal growth, Silicon Valley and San Francisco’s tech hubs are showing signs of a slowdown, and London could soon follow. Emily Wright meets CBRE’s Bay Area boss to find out more
In San Francisco’s Mission District you can buy a greeting card that is so indicative of the city’s start-up culture, you could not really be anywhere else. “Congratulations on closing your first round” it reads – the ultimate celebratory token in the world’s tech Mecca.
And why not? For some of the Bay Area tech companies, securing that all-important first influx of funding has led to success so great, so colossal and so public, it has been nothing short of mesmerising. Uber, the six-year-old taxi hailing company, is valued at $41bn (£29bn). Airbnb, which launched seven years ago, is valued at $26bn. But for every headline-grabbing success story, there are thousands of failures. Hardly a surprise when the term for a bone fide triumph (a $1bn valuation in the tech world) is “a unicorn”. Everyone gets the picture. Making it big is rare.
Now, eight years since the Bay Area kick-started what became a new wave of start-ups across the world, it is even harder. And not just for those at the start of their journey. As venture capital and angel investors keep a tighter rein on their investments against the backdrop of high-value companies refusing to publicly list, signs of a San Francisco slowdown are looming. And CBRE’s Bay Area vice chairman Dan Harvey is in the eye of the storm.
On a recent trip to London he took some time to explain how “nervous waters” in the area’s tech sector are affecting real estate and if we are likely to see a knock-on effect in London.
Getting the cash
There is no doubt that, over the past 12 months, investment in tech companies in San Francisco and Silicon Valley has slowed. Venture capital investment in the Bay Area fell by 32% to $11.3bn in the fourth quarter of 2015, compared with the previous three-month period, according to PwC. Bay Area companies releasing IPOs fell from 35 in 2014 to 26 last year, and jobs in the area’s tech industry increased by just 5.1% in January this year, compared with 10.5% in the same period the year before.
But why? Harvey says that apart from the fact that the Bay Area’s tech sector is reaching a natural tipping point as the cycle matures and the market becomes increasingly saturated, the real issue is stemming from investors. As they get wiser to start-ups’ ways and foibles, they are protecting themselves from the word go.
“The big question is around how venture capital and angel investors exit deals,” he says. “All these unicorn companies have these huge private valuations. But what does that mean if they won’t publicly list? Many of them wait for fear of the real life valuation being less than that. And then where is the value for the investor?
“Another issue from the investor side is this: you might come in at an early stage of funding and buy at a certain level based on a valuation, but then there is a risk the company will go public for less than that. What is happening now is the investors are putting clauses in these equity raises to protect themselves.”
The result, he adds, is making the cost of investment much higher for the companies raising the equity. The introduction of these ratchet terms into contracts means start-ups are expected to give more to safeguard early-round investors. “Companies are now having to issue more shares to secure that all-important early funding,” says Harvey.
“That is effectively to protect early investors from the possibility of a diluted public valuation. And as the capital becomes more expensive from the outset, not all companies will be able to afford to raise subsequent rounds.”
Tough on the companies that find they can no longer afford to raise the capital that just a few months ago was pretty easy to get hold of, as long as you had a decent idea and the right contacts. Now the ideas themselves are coming under increasing scrutiny, says Harvey. And only those with a fresh, new concept will be able to attract the cash. So that is the $1bn question. Which are the companies more likely to sink rather than swim? It is impossible to say across the board, but Harvey reveals a pattern that is emerging.
“Anything that provides a service your mother would once have done for you will find it tough now,” he says. “By that I mean laundry, cleaning services, errands apps. Things that, before you were an adult, someone else would have done. That part of the market is just so saturated now. There are hundreds and hundreds of apps and start-ups operating in this field now, so to attract investment, it really has to be something entirely new.”
Impact on rent
In terms of the impact of the changing market on the Bay Area’s real estate sector, Harvey says rates are not coming down, but more deals are being done as a sense of urgency starts to filter through the commercial sector.
“Landlords are getting their spaces leased up,” he says, “which is new. There is a sense of, ‘Let’s not hold off for another 5% bump in rates next year because those uplifts may not be coming.’ There is no panic. These are very strong landlords with very little debt on these properties. But what I am recognising is that there is a slowdown. A couple of years ago, things were so strong and tech occupiers were so wealthy, it was more like, ‘I am actually better off leaving my property vacant because things are going up so fast it may be worth more next month,’ and that is no longer the case.”
Harvey adds that rocketing residential prices in the city – they have grown by an average of 15% over the past five years – means start-ups are increasingly looking to live, and therefore work, elsewhere.
“For so long, there has been a desire to be here in San Francisco,” he says. “If you are a start-up or an entrepreneur, this is where there is purpose, meaning and new company formation. Then you get here and it’s suddenly, ‘Oh my god, I need six roommates to afford the rent and I am living in a broom closet.’ So they go to Oakland, San Francisco’s version of Brooklyn. It’s a 10-minute ride away and it has all the authentic elements of what the millennial workforce is looking for: the artists, the chefs, the musicians.”
He adds that this is not just happening in the Bay Area, rather it is a global phenomenon. And one that is not just seeing tech companies moving further out of one particular city, but relocating to cheaper ones altogether.
Coming to London
“What is happening in San Francisco is likely to be emulated in London,” says Harvey. “And anywhere that start-ups rely on VC and angel investment. It will get more expensive to get the capital and that won’t just result in a slowdown but could see the tech hubs relocate. People will start saying, ‘Can I afford to locate myself in a really expensive city? Or do I need to start pushing operations out to lower-cost locations?’”
He points to the likes of Phoenix and Portland in the US and places his bets on the Thames Valley and Manchester in the UK.
As for the knock-on effect from the Bay Area bubble bursting, how bad does Harvey think it might be in London, a city that has become synonymous with some of the best, most innovative thinking in the world?
“It will have a knock-on effect,” he says. “It has to. Not least because I am looking for the public markets to start to ask more of the companies who have gone public. If you think about how Wall Street has worked for five years, they have been focused not too much on earnings but growth. I think at some point you will see the public markets care more about earnings and put pressure on companies to rationalise their growth as opposed to grow at any cost. That will slow things down in San Francisco, but also New York and London. That is not to say there is this huge, dark cloud on the horizon. This is the natural progression of an aging cycle. It will get harder for tech, but not impossible.
“Europe also has its own dynamics and issues. The euro, Russia and Putin, Greece, growth and productivity – challenges different from the US… but there are always worries, right?”
Right. And the global tech industry should take comfort in the fact that, while challenging times might be on the horizon, they are more likely to result in a correction rather than a full-scale implosion.
Good news for innovation, VC investors and the start-ups that have the legs to make it big. Bad news for greeting card sales in San Francisco’s Mission District.
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