Starboard Commercial Real Estate

Hans Hansson | July 5, 2017

 

I recently attended an event organized by National Association of Realtors (NAR). Attending guests included senior board members from across the country. As I presented in cities large and small, I have quickly come to learn that there is a national shortage of both residential and industrial real estate.

The Supply Doesn’t Meet Demand

There is clearly a major population shift occurring from outer suburbs to inner cities. Cities from Amarillo to Cleveland are seeing changes in city-dwellers’ living habits, which create a real need for more urban development, particularly urban condos. Although development is happening, it’s not happening quick enough to supply the demand, therefore pricing has become unaffordable throughout the country.

Affordable housing was the center stage topic of the NAR convention.  Cities like Detroit are seeing major development throughout the city, but it’s not growing fast enough to gentrify areas caught in the middle of high crime areas. This results in high-crime neighborhoods surrounding the new development.

Not Enough Warehouses

The next area of shortages in Industrial or warehouse properties. Because rental rates have not kept pace with overall development costs, this type of property has been out of favor for new development for quite some time. Now, shortage exists everywhere, creating real challenges for businesses seeking to expand in their marketplace.  

For example, Napa Valley's industrial warehouse vacancies are now at 1.3 percent. Yes, with the expanding wine industry, businesses are finding themselves choked off for growth because they don’t have enough warehouse space to store their product.

In Hayward, where the industrial vacancy is only one percent, small to big businesses can’t find any warehouse space available because none have been developed for so long.

The challenge with these shortages rest in the length of time it takes from acquisition to permitting to the actual building process.  All markets are experiencing long delays in securing permits, thereby creating more pressure on shortages in the marketplace.

So, what’s going on? Clearly, we are seeing continued growth in our economy, but typically housing shortages are caused by population, not economic growth.

Lifestyle Changes Force Industry Changes

One fact that I was discussed that I would never have guessed is the size of the millennial generation. I assumed incorrectly that the Baby Boomers still represent the largest population block. However, that is not the case. Today, there are roughly around 60 million baby boomers, but over 100 million Millennials– making Millennials the winner of the market share. As we continue to develop, it’s important to keep in mind what Millennials want.

 

According to a recent study from the Urban Land Institute, Millennials identify themselves with the following words: entitlement, connection, ambition and innovation. Each of these words directly correlate with the lifestyle and real estate Millennials demand.

Convenience is a top priority for urban Millennials on the house hunt, and residential mixed-use spaces are a part of the solution to address their needs. Crucial needs for living space includes walkable distance to public transportation, amenities such as an at-home gym, nearby dining and entertainment. As population density in urban areas continue to climb, it’s important that cities develop properties that the bulk of the market would be interested in investing in.

 

Photo Credit: investmentzen Flickr via Compfight cc


Hans Hansson | May 19, 2017

Industrial SpaceToday, office vacancy throughout the Bay Area is on average at five percent. Planned office development is taking place in San Francisco, San Jose, and Oakland to meet the office market demands. Retail vacancy is also around six percent. We still see new retail projects underway, while larger retailers across the country continue to close their brick-and-mortar stores and try to find new ways to survive in the ecommerce marketplace.

However, the lowest vacancy factor in all available commercial real estate sectors is industrial. Today, the overall industrial vacancy rates are at around three percent. In industrial heavy markets like Hayward, the overall vacancy is under two percent. Yet, there are almost no industrial projects in progress to address.

As a commercial real estate firm, the highest requested space that we receive inquiries on is for 10,000-20,000 square feet of warehouse space in the Hayward market. Unfortunately, it simply does not exist.

Even more challenging is that our warehouse market overall is old and obsolete. For instance, in San Francisco, there has not been a large warehouse industrial project built since the 1980's. Most of our warehouse stock was built before and during World War II to address the need of building navy ships. Most warehouse units are underpowered and cannot address the needs of today's offices that are typically included with warehouse space. Today's industrial space calls for power, sprinkler systems, high ceilings, and the ability to stack three-four palates on top of one another. Properties with this checklist are almost non-existent.

Why then do developers not build warehouse space? The first reason is leasing costs. Warehouse tenants often have a lot smaller budget to work with. Therefore, the cost to acquire land and make economic sense of the development is challenging. The second reason deals with return on investment for developers. Warehouse space requires access for large trucks and requires larger parking areas. This requires more common area land that developers need to include in their planning, which means they will need to buy land at a much lower cost to accommodate– which is not easy to find.

If we do not develop warehouse and industrial space, we will face even more congestion on our freeways, as trucks will have to venture farther away into the central valley to bring in goods to the Bay Area.

Zoning restrictions have been implemented in Bay Area cities, including San Francisco, to try to force development of more warehouse space. However, in the end, land is simply too expensive and the process to get a project up and running will take years since all projects must go through the planning process (typically up to two years from start date). Without a regional approach from our government officials to support our need for more warehouse and industrial property, we risk impeding our economic growth.

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Hans Hansson | April 24, 2017

Shopping CenterIn the 1950's, President Eisenhower launched the development of our national freeway system. This lead to the development of our suburbs and major urban cities throughout the United States. Shopping centers where created around this time and became an alternative to outdoor downtown malls.

Shopping Centers were built with typically two to three anchor tenants like a Sears, Macys or a JC Penny's. They typically paid little to no rent in favor of drawing traffic to the smaller retailers that paid high rent to be near the retail giants. At this time, it was the smaller retailers that made the shopping centers profitable.

Today, we see all major retailers are struggling to survive. Sears and JC Penney are at the end of their lifecycles, with Macy's not too far behind. These retailers in American malls are challenged with an oversupply of retail space as customers continue to rapidly migrate to online shopping, as well as fast fashion retailers like H&M and off-price stores such as T.J. Maxx.

As a result, about 400 of the country's 1,100 enclosed malls will fail in the upcoming years. As shopping centers lose large retail anchors, with no comparable prospects to replace them, it's only a matter of time before the smaller surrounding retailers also die out from losing shopper foot traffic.

Retail analyst, Jan Kniffen shared that about one-third of malls in the U.S. will shut their doors in the coming years. These vacant spaces will create large blocks of abandoned real estate that will take its toll on surrounding areas within urban cities and suburbs.

Developers and current owners of shopping centers are working to reinvent themselves quickly and appeal to a different demographic – the Millennials. Those born between 1982 and 2002 are living very different lives than previous generations, therefore have different needs and desires.

Millennials will typically not cook at home, yet seek healthier meals and fun ways to stay fit. They also remain single much longer while waiting to have kids. Thus, several shopping centers across the U.S. are starting to convert a portion of their space for residential use, while keeping retail on the ground level– housing convenient yet healthy food options and trendy fitness studios like Soul Cycle and Barry's Bootcamp.

In addition, collective shopping centers, also known as "emporiums" are back where a large warehouse space is divided into smaller micro-stores, selling food, art, clothes, furniture, and more. "The Mix" for example in Southern California is a current success story of this rising model.

Shopping center owners are also marketing to shoppers that they sell "anything that can't be found on Amazon." Stores like Nordstrom's and Petco are also offering "delivery pick-ups" within their store to support their own online sales. The ever-growing ecommerce giant, Amazon, is rumored to be testing a grocery store concept that would allow deliveries to come out of their brick-and-mortar stores.

We are entering a crossroads generationally that is causing retailers to question long-term strategies. The last of the baby boomers are now entering their 60's. They have the financial resources but many find they have everything they need and are not spending like previous generations that hit the later years and would like to reward their life efforts with luxuries.

The Millennials tend to want it all, without putting in as much work. Quality is less important than fast, cheap, and interesting. A step down in appearance is a death sentence for any men and womens apparel stores. Even "middle of the road" retailers such as the Men's Warehouse have been forced to slash prices of suits and traditional wear so low that the whole quality appearance of their suits is compromised.

Although it's inevitable that malls will be converted to new uses over time, city zoning regulations could impede the reconstruction of these sites, leaving cities and suburbs with major holes that could lead to blight. For example, in Reno there is a major economically valued street with a large shopping center that closed five years ago. The center was left abandoned and then demolished, leaving a major street with a large vacant lot surrounded by other retailers which are also quickly dying out.

The next generation of retailers will emerge and bring about very different ideas. But one thing remains certain– our local governments need to be able to streamline their ability to respond to developers and current shopping centers quickly when approached with new ideas. If they can't respond in a timely manner, there will be serious financial consequences.

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Hans Hansson | March 6, 2017

San FranciscoFor years, San Francisco has been tackling a major housing crisis. At an average of over $4,500/month for a two-bedroom apartment, San Francisco has become the most expensive city in the US. As reported by CITI bank, the cost of housing is unaffordable for 73% of San Franciscans and Federal and State support for affordable homes has declined significantly over the last decade. So, what is being done to solve this issue?


Across various stages of the permit process, there are over 40,000 potential affordable housing units yet to be built today. With rents still sky-high, several people have been evicted from their homes and often forced to live in smaller quarters with more tenants. Otherwise, they are simply priced out of the market altogether.


Last year 5,000 new units were added to date and overall residential rents have also dropped eight percent, proving that the more units we build, the lower rents will drop.


HIGH RISK, LOW RETURN


Today, a developer starting from scratch would be waiting over two years to just secure a building permit. They start the process with absolutely no guarantees of receiving approval to build. In turn, the development process gets more expensive, increasing overall costs at completion, which calls for a higher sale price and rental rates to justify the risk and overall investment.


In New York City, similar projects would take between 18 months and two years. That includes securing necessary building permits and construction. So, why does it take so long in San Francisco?


The common response to this question is "understaffing," but if the city truly has a housing crisis, we should be able to solve a staffing issue.


THE PRESSURE CONTINUES


The City continues to push for more affordable housing, with recent public support of The San Francisco Housing Accelerator Fund, who's mission is to accelerate the preservation and production of over 1,500 units of affordable housing over its first five years.


This will require developers to take on more risk while cutting more profit out of projects. As a result, there are several development sites available on the market while others have dropped out altogether. Click HERE to see a complete list of San Francisco's plans and projects.


With such a simple solution to expedite permits and get more units built sooner than later, why is the city pushing for more affordable housing units?


The real answer is because they know there's no real growth. City officials want to stop housing growth to stop what they perceive to be the continued gentrification of our city. By pushing affordable housing, it appears that the City wants to solve the lack of affordable housing issue, however it's inevitable that the exact opposite will occur.


As a native San Franciscan, I too am concerned about the growth of our city and how our city has already changed in many cases for the worse due to our growth. However, I am also aware that is ultimately the ebbs and flow of our City's "supply and demand" in which we fail to control, particularly when economies enter a retraction.


Anti-growth finds its equilibrium, letting supply and demand take its course. If all 40,000 units were built now, then rents and sale prices would go down as well. We need to remove bureaucracy, expedite housing permits, and let the market correct itself naturally.


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Hans Hansson | February 27, 2017

Retail shop windowThe counties of San Mateo and Marin reported rates of 2.7 percent and 2.9 percent. San Francisco reported unemployment of 3 percent, while Santa Clara County reported unemployment of 3.3 percent.

Although the Bay Area is in a healthy state, we are constantly seeing understaffed businesses. Lines wrap around corners for our favorite dining spots, while tables are available inside. It's next to impossible to find help in clothing stores like Nordstrom's or even your local retail shop. Car wash operations in San Francisco are closing mid-week just because they can't find enough workers to keep their business open.

Local restaurants complain that they cannot hire full time employees and instead rely on part time workers. Part time employees will often take a couple of shifts here and there, but leave key shifts open, leaving holes in coverage.

Our Biggest Hurdles

So, what is the cause and what can be done to fix it?

  1. The biggest problem we have are wages. The minimum wage in San Francisco is $13.00/hour, which simply isn't enough to support overall costs to live here. As of this year, the average apartment rent within the city of San Francisco, CA is $3,871. Real minimum wages have pushed beyond $15.00 an hour throughout the Bay Area, but it's still simply not enough.
  2. The next challenge is that most employees of entry level jobs typically come from high schools and universities. Most students don't live in the city anymore to save money and are more interested in securing strategic internships in their desired professions versus taking a job that will simply provide a base income– not a career.
  3. Local government requirements on businesses are also job-killers. The rise in "paternity leave" as a benefit has cut business margins down further at a time where both rent and wages continue to increase. In addition, building and zoning requirements a re prolonging the process for new businesses to get up and running. They end up spending a lump sum of time and money with uncertain results, so they pass on opportunities to lease in new locations. For example, we see San Francisco's Post street downtown with a large number of vacant spaces and Union street with over 18 vacant stories just this year.

What Needs to Change

  1. Government needs to adjust regulations. We need the government to take note and make real changes in regulations that take too long to comply with an are too expensive.
  2. Create real job programs within our inner cities. We need programs that highlight opportunities that are available to the most unemployed or underemployed and then create job training that fits training to jobs. An example of this is how Germany trains people to enter retail jobs. Germany requires interested citizens to go through extensive training on how to service and sell in retail. These training programs would need to be promoted to our high schools, where young students would be interested in an entry level job opportunity.

    These entry level jobs teach the basics of learning how to work. From serving clients to selling to inventory, handling cash and credit cards, to learning how businesses operate, training would be beneficial for both the employee and the employer.
  3. Government needs to partner with retailers. If government and businesses form a partnership, they can be proactive together and help find more employees. If we don't, businesses will not be able to run operations and will eventually fail – which will affect everyone.

Change is in order. Otherwise, we will continue to see a steep progression in understaffed businesses and will eventually see these operations close shop.

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Hans Hansson | January 16, 2017

Interest Rates in 2017With a new administration entering office and discussion of corporate tax cuts, regulation cuts, and domestic job growth continue to be top of mind, we can rest assured that interest rates will finally rise. The question is how will this affect the real estate market?

Historically, low interest rates have helped the real estate market in accelerating growth in-turn for historically high prices. A lot of these high-water marks in pricing have occurred because of more affordable payments, therefore higher prices were justified.

If interest rates were to jump to 5 or 6 percent in the next 18 months, how would that effect commercial real estate prices? Certainly, cost of funds mean higher costs to finance. However, higher interest rates could also potentially drive down prices, since people would be seeking higher cap rate return adjustments to new interest costs.

Today you could purchase an office building for a 5 percent cap based on a 4 percent loan. If interest rates were to go up to 7 percent, which is more towards historical average, you would then have to buy the same asset at an 8 percent cap.

An example of how that could affect values is if you had a building generating $100,000 of net income and you purchased the building at a 5 percent cap today, then the building would be worth around two million dollars. If the same building were sold at an 8 percent cap, then the building would be worth $1,250,000 to $750,000 negative net difference.

If this is true, then raising interest rates could do real harm to real estate values, correct? Well, maybe.

There are still a few deciding factors:

Dollar Value
It appears that the dollar will continue to see stronger values against all other international currencies. If Japanese buyers for instance cannot only earn 1 to 2 percent in their country on investments, then a cap rate of 5 percent for an office building may look like an attractive alternative investment.

Economy Growth
If our economy grows, commercial real estate leasing should also be in higher demand. Office, industrial, and retail tenants will look to expand. But if the demand is not met with supply, this will shoot up rental rates, which means higher net income to capitalize value.

Foreign Investments
Foreign investments however do not necessarily lead to ultimate adjustment of values. In the 1980s, the US was faced with a similar marketplace. Overseas buyers would purchase many of our trophy properties throughout the United States– including buildings such as the Rockefeller Center– only to see their building values tumble down when they needed to sell. At that time, no strategic buyers were willing to pay the cap rates lower than the current interest rates.

It's still too early to tell what direction the market will take until our new administration implements plans for the economy. My guess is that we are going to see much higher interest rates, but more foreign demand – which will curve any price value reductions due to higher interest rates. Only time will tell...

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Hans Hansson | November 8, 2016

San Francisco office rentsOver the course of the last three years, there has been an explosion of office and retail property sales. Any commercial building put on the market has sold quickly– and with multiple offers. We've also experience unsolicited offers on buildings at never-before-seen prices also sold.

How We Got Here
The two principal reasons for this was because San Francisco office rents were skyrocketing toward a New York City price tag. Retail rents were considered undervalued to any major city in the world, both in terms of rent and value per square foot. Speculative buyers, particularly from New York, have come in and purchased several buildings that have not traded hands in generations.

This entire boom has occurred because of our quick growth in technology, which is now in its fifth year of its cycle (the boom-and-bust year of 2001 had lasted four years). But what happens if the tech boom softens, or worse, collapses due to high building rents?

Our Current State
Well today, the market is in fact cooling. As reported in the San Francisco Business Times this month, office leasing activity in the city fell to 875,000 square feet in the third quarter as big deals are scarce and tenants are more cautious.

This was the lowest third-quarter activity since 2001, and a dip from the 1.3 million square feet of leasing in the second quarter and 1.1 million square feet in the first quarter.

Let's step back and look at office rents before the current boom cycle. Average Class A rents were around $32.00/square foot. While today, rents are around $69.00/ square foot.

When you take the tech tenants out of the market equation, conventional businesses during this boom actually saw some growth, but on average there was no real growth beyond a single digit annual growth. Yet, San Francisco's high rents would require conventional firms to grow at a high double-digit rate in order for conventional businesses to afford to stay.

Retailers are faced with similar challenges, along with a looming industry conundrum as online sales continue to close all brick-and-mortar stores and purchase behaviors of the millennial generation continue to evolve.

San Francisco's largest tech players all face serious uncertain times– Yelp, Twitter, LinkedIn and Dropbox once hailed as industry disruptors have all been struggling to continue to grow, let alone survive in their markets. These are just a few of the struggling tech giants who lease the majority of the commercial space in our city. In addition, there is a large number of new office spaces being developed, which will add to potential weakness in office rents.

Will Rents Lower?
In the retail world, you already see major holes of vacant retail in the city, including areas surrounding Geary Street, Post Street, and Sutter Street with stores like Prada and Saks Fifth Avenue Men's Store closing. In other words, we are seeing major blocks of space coming back to market, yet rental prices are still holding firm– why is this?

Buying buildings today is not about cash flow. It's about building value and a landlord's ability to maintain and/or grow that value over time. Buildings that have been traded recently at high prices based upon today's rental rate have been purchased too soon to deal with any market reality changes.

These conventional tenants haven't seen enough growth to support paying current rents, so they will likely instead leave current spaces vacant until either the market grows again, or until building appraises start showing that the values have been lost, therefore releasing new appraisals that will bring down values enough to begin leasing at lower rates.

So, as tenants in the market today, you are a bit too early to enjoy rent reductions. Best thing for tenants in the market place today to do would be to look for buildings that have not traded in this cycle and can meet true market rents, because they can afford to do so.

If you are in a building that recently traded hands, you will fully need to inspect before moving, because your new landlord will have no liability to cut deals soon after buying.

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Hans Hansson | October 26, 2016

Real Estate Economic Committee UpdateThe Bureau of Economic Analysis “final? GDP estimate for the Second Quarter was released on September 29th, and showed overall economic growth at a 1.4 percent annual rate. This was the third consecutive sub-par quarter, and confirmed that the long expansion (now at 86 months in duration) is slowing its momentum. While the initial Third Quarter estimate will not be out until early November, preliminary data indicate continued sluggishness. Retail sales are up just 1.9 percent year over year. Housing starts, permits, and home prices slipped during the summer. Industrial production and capacity utilization are also in decline from 2015.

More positively, net real exports have risen for the last several months, and this should be strengthening GDP during the second half. The auto industry has also been trending upward. Incomes have started to rise, and for the first time in this cycle lower and middle-income households are benefiting materially, according to a Census Bureau study released in September. This is contributing to a small uptick in inflation, with core CPI now up 2.3 percent year over year.

Jobs. Employment growth has decelerated in 2016, averaging just 178,000 monthly through September. That’s a 1.7 percent annual growth rate, down from the 2.1 percent rate in 2015, but still enough to add 2,447,000 jobs to the economy for the 12 months ending September 2016. Business and professional services, healthcare, retail trade, and food services led the growth, indicating that job growth is positively spread across a variety of worker skill levels. The BLS “JOLTS? report (Job Openings and Labor Turnover Survey) shows twice as many workers quitting jobs compared with layoffs, indicating improving worker confidence. About 5.4 million job openings were reported in August (the most recent data published), and there were 5.2 million hirings that month. The unemployment rate stood at 5.0 percent, and has been relatively stable during the past year.

Read more: West_Q3_State_of_Market.pdf


Economist Hugh F. Kelly, PhD, CRE, who leads TCN's Real Estate Economic Committee, is a Clinical Professor at New York University’s Schack Institute of Real Estate where he has taught for 30 years. He is widely cited in the real estate industry and is well known for his research on 24-hour cities and commercial real estate investment performance.


Hans Hansson | September 19, 2016

Commercial PropertiesI just attended the TCN Worldwide national convention, held in New Orleans, LA, where I was educated on interesting overall market activity. With agents speaking from around the world, one theme was consistently heard - there is nothing more to buy... anywhere.

With interest rates at historical all-time lows, people, institutions, and owners have all migrated to real estate. As a result, there are limited quantities of property available and virtually no deals to be made.

Today, in downtown Manhattan there are no more than five to six commercial properties available at any given time. In San Francisco, a major office building – One Front Street – sold this week for a high water price, even though the overall market is showing signs of slowing down and rental rates are starting to drop for the first time in years.

In Kansas City, developers are planning an additional seven million square feet of new construction for industrial products, all listed as "spec buildouts." With rental rates at 35 cents to 45 cents on average, the margins are thin even if they are successful in securing tenants quickly.

Costs to purchase land and build are running $50 to $60/square foot. With this cost and taking into consideration the current rental rates, you are looking at a six to seven cap rate. Yet, there are industrial properties in Kansas City trading as high at $75/square foot, making older-leased buildings sell far below these cap rates. Of course a two to three percent return is much better than most bank accounts, but any upturn in interest rates will eventually force these sale values down.

With more products available online, the likelihood of higher rental rates in the future do not seem realistic to allow owners to use future higher rental rates in order to secure higher building values.

Retail prices in major cities like New York are selling at over $1,200 to $1,500/ square foot, yet retailers that would pay the rent to support that purchase price are balking and no longer willing to pay such high rental rates. With changing consumer demographics and buying habits, long-term, higher-end goods particularly in brick-and-mortar locations are already struggling to compete with online sale alternatives.

In secondary rental markets such as Omaha – from single residential homes to apartment buildings – brokers suggest that the market for deals passed two years ago.

In England, even with plans to leave the EU, are still seeing significant buyers from Germany and the Middle East, flooding the market even as rent growth continues to slow.

So long as interest rates remain low throughout the world, I would expect little exchange in properties. However, if the U.S. raises interest rates, the potential negative effect on current prices could easily be offset with more overseas buyers making deals in the US. Only time will tell...

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Hans Hansson | August 26, 2016

Office RentWhen you are in a hot market like we are experiencing in the San Francisco-Bay Area, affordable office space is hard to come by. According to Colliers International Research and Forecast Report for San Francisco in 2016, overall weighted office rent averaged about $80.42 per square ft. for class A space, a 9.5 percent increase from just last quarter.

Most clients I see today look for office space and rush the process. They want to secure a new space as quickly as possible, rather than taking the time to determine if the space is truly affordable for their business long-term.

I see this especially ring true with most tech tenants we work with. Often times, these firms are newly funded and in development mode. Therefore, rent is not the most important factor for them.

These tenants are focused on securing a space quickly so that they can hire the talent they need to launch their business and start making profits. Regardless of the reason, at the end of the day, rent needs to be paid. And if rent is too high, it will impact a business' revenue stream along with every other aspect of the business.

As a rule of thumb, I have always determined the amount of rent a business is able to pay is typically between six to eight percent of its gross sales. However, today's office layouts have changed so drastically to the point where there are more people situated in less space. In years past, the rule of thumb had been 200 square feet per person. That was based off an office space that was comprised of 60 percent private space and 40 percent of open space. It also includes a good share of conference rooms, kitchen area, and storage areas.

Today's office arrangement looks quite different. With less use of phones and more use of emails, instant messaging, and texting to conduct business, the need for private office space has reduced significantly. Also, companies today have a collaborative work culture. Instead of isolating cubicles, workstations have been replaced with long conference-style work tables, which are much more conducive to collaboration and conversation. As a result, businesses are squeezing more people into less square footage.

Today, it is not uncommon to see offices with less than 150 square feet per person or close to the minimum legal square footage of 100 square feet per person.

To address growth, I often hear clients tell me that they will just add more chairs to their existing workspaces, rather than moving to a larger space. Clearly, this is not a plan to make their businesses more efficient, but really it's just a sign of not wanting to deal with the moving process at all. Although conventional businesses are a different story, their approach to growth are similar. These businesses are more focused on remaining profitable and their increasing their bottom line. Squeezing in more talent while working in smaller spaces does ease the burden of higher rent rates in the Bay Area.

Five years ago, the average rent for Class A office space in San Francisco was only $32.00 per square foot; a much more affordable price tag than today's average of $82.00 a square foot.

Today, the average square footage office user in San Francisco is only 3,000 square feet, holding 15 people. Five years ago, the annual rent was only around $96,000 (or $6,400 per person). Fast forward to present day, assuming 150 square feet per person, a 3,000 square foot space holds 20 people, which puts today's annual rent at around $216,000 (or $10,800 per person).

Conventional businesses have not yet seen enough multi-digit growth over the last five years as a reason to absorb such an increase. Certainly, with real signs of the market softening, they cannot count on this level of growth to continue.

Tech companies, particularly startups, haven't cared about cost of rent in the recent past. Why? Although they were forced to sign longer-term leases, some with three to five years of commitment, their business model for success was not based upon profitability. It's been based upon the ability of the business to get acquired or go public. But as capital continues to dry up and firms are struggling to continue to exist, they will need to be more cautious about their rental costs.

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