By Garrick Brown, Vice President, Research – West Region
Let me start with this… YES, Oakland Coliseumfor one of my stories of the week I actually chose a piece from The Onion. And, YES, I do know that the Onion is a satire newspaper thank you very much. In case you are not aware of the Onion, you really ought to be. Along with the Nihilist Arby’s Twitter feed, it probably is the most consistently hilarious website in existence. So when I saw the headline yesterday with an Oakland byline that read; House Prices Spike as Tech Employee Strolls through Neighborhood, I just knew this was going to be a winner.
All chuckles aside, the Onion piece came out on the same day that Zillow released a survey that found that, on average, San Francisco residents spend a whopping 47% of their income on rent. This news also came on the same day that the estimable Roland Li had a great column in the San Francisco Business Times; ‘It’s Starting to Feel a Little Bit Like 2007’: Why Oakland Risks Missing Out on the Boom.
So if you are in my business you would have to be blind if you haven’t noticed a clear shift in local sentiment in recent months. I speak frequently on panels for different commercial real estate related events (come see me tonight in Oakland with the Urban Land Institute—details below). Perhaps the most frequently asked question I get from the audience is the classic baseball game analogy question; “If the overall economic cycle were a baseball game, what inning is it?”
The lion’s share of responses this time last year was that it was the fifth or sixth inning… sure, last year I heard a few people building plausible cases for it still being in the fourth inning. And I know of a couple of people who have been saying it was the ninth inning going all the way back to 2012. But the general sentiment was that this expansionary phase of the economy still had a pretty decent amount of runway left to it.
Increasingly this year (particularly since the stock market volatility of August), that answer—when posed to panels I have participated on has overwhelmingly been seventh or eighth inning. Though Wall Street has increasingly stabilized since then (and the October jobs report—plus 271,000 new positions—was back to the kind of exemplary numbers we saw late last year), I haven’t seen sentiment improve much.
That’s not necessarily a bad thing. Clearly there is a sense we are “due” for a downturn in terms of just looking at the calendar. The average expansionary period since WWII in the United States has lasted about five years. That being said, the biggest expansion in our history was during the 1990s when we saw ten consecutive years of growth (1992 to 2001). And though the economy has technically been in growth mode for seven years (since mid-2009), it has to be argued like this recovery has been like no other in our history. Monetary policy is at the root of that, but realistically if you ask the average person in San Francisco when recovery began they will tell you 2010 or 2011. Ask that same question of someone in the Midwest and we’re probably talking about 2012 or even 2013. But the reality is that downturns don’t just come out of nowhere and so the calendar is not exactly what we should be looking at.
That being said, there are reasons for concern and locally it all comes back to the tech sector and, most prominently, unicorns. My good friend, Mark McGranahan, who specializes in office leasing for our San Francisco office, shared with me a few interesting quotes I thought worth sharing from a number of those active in the venture capital world with concerns;
“Either we’ve discovered magical beans and elixir or perhaps we’ve gotten ahead of ourselves on valuation.” –Mark Suster, Partner of Upfront Ventures
“The thing that worries me the most about all these [billion-dollar valuations] is that you need a public market to get liquid.” “But who’s going to buy at these valuations? It’s all priced for perfection.” –Chris Douvos, Partner of Upfront Ventures
“The Age of the Unicorns is ending, but the Age of the Cockroaches is beginning. All hail!”—Caterina Fake, Founder & CEO of Findery; Co-Founder of Flickr & Hunch
“Despite the chatter about an overheated market, the appetite for investment into fast-growing private startup companies remains insatiable. Q3 2015 marks another dot com level high for funding and this has become the new normal it seems. Investor FOMO (fear of missing out) continues to be a key driver of mega-financings and doesn’t look to abate anytime soon.”—Anand Sanwal, Founder & CEO of CB Insights
“Time for entrepreneurs to strap down, don’t waste cash, not going to be as abundantly available as before. Build advantage, focus.”—Nikesh Arora, President of Softbank
All of these quotes are thought compelling at the least and while I certainly have deep concerns over startups and unicorns… and have a hunch there may be a dead unicorn or two in our future, those who would draw comparisons to the dot.com days are still way, way off. In those days, almost all of the commercial real estate demand that we saw for office and R&D space was being driven unproven (i.e. unprofitable) players. When they tumbled, the market went with it. One of my broker friends shared with me that most of the active requirements for office space he was working on right now in San Francisco were for unicorns or, as of yet, unproven business models driven by start-up funding. But let’s not confuse this higher risk segment of the marketplace with who has actually been driving the lion’s share of the occupancy growth in the region over the past five years. We’ve recorded over 50 million square feet of occupancy growth in the region since local recovery began in Q2 2010 and nearly 80% of that has been driven by the very, very profitable giants (I.E. Google, Apple, Samsung, Facebook, etc.).
None of this is to say that there isn’t a heightened sense of risk with the new players looking to ramp up right now, but clearly that last quote from Nikesh Arora of Softbank sums up the new mentality… which is that venture capitalists are increasingly going to be keeping a tight leash on the companies they fund and will want to see results. This is probably a very good thing—certainly the opposite of the irrational exuberance that we saw on the eve of the dot.com crash.
But what’s it got to do with Oakland? Well, the greatest challenge for any developer is market timing. More often than not your ground-up development project, even in a pro-growth city that minimizes hurdles and encourages business growth, is going to be at least a two year endeavor.
You will have a hard time finding any economist currently who would tell you that they would guarantee that we have two more years of runway in this expansionary period. That’s not because we don’t. Truth is it becomes nearly impossible to predict more than two years out simply because of the innumerable unknowns that exist from black swans to mere market driven phenomena. But there is the increasing sense that we are entering into the late stages of this recovery. So if you are a developer, taking that into account, what do you do when it comes to Oakland?
I’ve been touting the “Oakland is the New Brooklyn” line for so long that I’m sick of it myself. But it’s true this time. However, something you need to keep in mind is that the transformation of that once troubled borough to being one of the “hippest” and priciest locals in the United States actually took a couple of real estate cycles. The groundwork was laid in the late 1990s when pricing in Manhattan and a few key urban revitalization projects began. The trend gradually continued in the 2002 to 2007 expansion. And it exploded in this cycle. It’s going to happen a lot faster with Oakland.
So do I disagree with any of Roland Li’s takes in his Business Times piece, or those expressed by the movers and shakers he quoted? Not really. I do think we will see a couple of new office projects get going, but no big office construction boom this cycle. In fact, if we are talking about who is in the best position to land big tech tenants currently looking for space in the region but that don’t want San Francisco pricing, Downtown San Jose has an incredible opportunity here because available existing space actually exists there and Downtown San Jose has already been in the midst of a multifamily boom.
But here is where I think that concerns that Oakland will miss out entirely miss the mark. Multifamily is going to flourish here as quickly as you can put it up and assuming that we hit a normal, “garden variety recession” with the next downturn that isn’t going to change. And though we all may still have the scars of having lived through 2008 and The Great Recession, that most likely was a once-in-a-professional-career type of recession.
Did apartment rents fall in San Francisco and San Jose during the recession? Yes, but only for about 18 months and the total drop was in the 5.0% to 6.0% range. Though Oakland rents are climbing fast, we are still tracking an average asking rent of about $2,200 per month in Alameda County for apartments. That number is edging in on $3,600 per month in San Francisco and sharp gaps remain in place between East Bay rents and those in San Mateo County, Silicon Valley and the North Bay.
Again, assuming a “normal” recession over the next 18 to 36 months, would that dynamic sink East Bay multifamily? Not at all; because of that pricing gap demand in a more challenging economic time might actually increase as the region’s most expensive markets struggle. And getting back to Brooklyn, it is only recently that we have begun to see significantly ramped up levels of office and retail expansion there… and that is nearly 15 years after the “overnight” Brooklyn renaissance began. Oakland won’t have to wait that long and as far as it goes for multifamily development there… it doesn’t matter what inning it is right now because that game is going to extra innings.
P.S. The last Story of the Week I included is the one that gives me the most hope. I’ll still argue with anyone that the biggest threat to our local economy aren’t unicorn valuations being out of whack, but the issue of our skyrocketing cost of living. At the root of that is our housing crisis and the Bay Area Council gets it. Read their report. The solution starts there.
This post is commentary from the latest weekly edition of our Bay Area Research Rant, which you can subscribe to for free by e-mailing email@example.com.
Garrick joined Cushman & Wakefield (formerly DTZ / Cassidy Turley) in October 2010. He serves as Vice President of Retail Research for the Americas. He speaks frequently at industry events and has been a keynote speaker at symposiums, conferences and market forecasting events for groups like the Appraisal Institute, Urban Land Institute, CREW, ICSC and PRSM. He is also a member of Lambda Alpha International, an invitation-only land use society for those who are involved in the ownership, management, regulation and conservation of land, but also those who are involved in its development, redevelopment and preservation.