This is not another Dot-Com bubble

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In 2011 Silicon Valley absorbed office and R&D space at a rate to rival all but the biggest boom years of the Dot-Com bubble.

"We’ve just had five-straight quarters of hefty reductions of available space and we’re not seeing any let-up in sight. In 2011, the Valley finally took off in terms of gross absorption, which translated into 27.9 million square feet for the year or a 28% increase over 2010. We had 30 new office/R&D deals above 100,000 square feet in Santa Clara County in 2011 and half of those were above 200,000 square feet. While the volume of large deals may not be repeatable, the Valley is poised to generate more net absorption in 2012, even with a little less gross absorption.”
Jeff Fredericks, Managing Partner in the Silicon Valley office of Colliers International, on Silicon Valley Trends 2012, Press Release 2/15/2012

Colliers’ forecast is for 27 million square feet of gross absorption for Silicon Valley in 2012, with six million square feet of positive net absorption. According to Colliers the vacancy rate in downtown Palo Alto for grade “A” office space is currently 0%. Office vacancy for Mountain View is in the low single digits. With the space being reserved by Apple taken out of the inventory, Sunnyvale’s office vacancy will also fall into the single digit range. Rents are up 30% to 50% in the strongest locations when measured to the depths seen after the credit crunch two years ago.

Are we in a repeat of the Dot-Com Boom? I put this question to several knowledgeable market participants; their responses are unanimous.

Kevin Catlett at Principal Real Estate Investors: “The current growth in absorption is amazing. We believe a key difference is that this time a lot of Silicon Valley’s growth is coming from companies with proven business models and real profits. Last time we had a boom largely based on VC funding; this time more of these companies are financing themselves from their own cash flow. ”

Geoff Hubbard, Research Director for the Silicon Valley office of Kidder Mathews: “The leasing data for the last 12 months shows that the largest transactions are by large, established, public companies such as Google or Apple. Google is pretty much taking everything they can in Mountain View while Apple is doing the same in Cupertino. With available space in Mountain View and Cupertino becoming scarce, they’re both expanding their footprint into Sunnyvale and surrounding areas.”
Google bought and leased 1.9 million square feet of space in 2011. To put this in perspective, this is three times the absorption of the entire San Francisco Office market in a good year. Apple is also grabbing space; if they complete the deals currently under negotiation they will have leased 1.1 million square feet in Sunnyvale in the last 12 months.

Chris Keith, Commercial Developer, at the Mozart Development Company lists nine reasons why this time it is different:

1. Corporate diversification and products within Silicon Valley markets is dynamic and broad with worldwide audience of product buyers.
2. Profitability is paramount and thriving (although I feel overall corporate growth and profitability will stabilize to a rational level, long term – stabilizing rents).
3. VC money is not available for unrealistic, unprofitable models. Venture money is being distributed wisely this time around.
4. Corporate profits and capital accounts are healthy.
5. For those companies that are marginal, costs have been cut, space shed, liabilities minimized, efficiencies realized - growth will occur slowly; if economic circumstances change most of these companies will not get caught with their pants down again.
6. For most firms we talk to current expansion is conservatively based (on current – 1 year growth) with fiscally solvent companies.
7. Shadow space and subleasing, today is almost non-existent.
8. Silicon Valley and surrounding area(s) will continue to attract the highest level of intellectual talent and corporate executives, managers, engineers in the world – the infrastructure has taken decades to build, billions spent by companies, cannot be easily replicated. To save costs support talent, manufacturing and assembly will be sent to secondary locations.
9. Silicon Valley specializes in the cutting edge technologies: The lowest price-point argument does not support intellectual property at inception.

Is this just a space-grab by the big profitable players?

There is definitely some of this going on. The leasing data is top heavy. But commercial property investors need to understand the changes in the typical business plan in the CEO’s desk of the average Silicon Valley start-up. It used to be: Get VC funding - Establish our value proposition - Go public with an Initial Public Offering. Now the typical business plan is to eschew VC funding as much as possible: Use funding from cash flow, customer partners, friends, family and angel investors. The exit strategy is not an IPO but to sell the company or product to Oracle, Google, Apple or Cisco.

These large companies have replaced the IPO option as the investor's exit strategy for much of the Tech world. Last time the growth in IT was reflected in lots of relatively small independent companies being housed by the commercial real estate community. This time these tech leaders are folding into the giants. Google bought 48 companies or packages of intellectual property in 2010 for $1.8 billion. In 2011 Google bought 79 firms or their inventions; I do not have Google total 2011 costs, but the the top three added up to $941 million. And already in 2012, Google's acquisition of Motorola Mobility at $12.5 billion was just approved by the EU and US Fair Trade Commissions. The appetites of Oracle, Apple, Cisco and the other mega players are equally impressive.

Will this pace of growth continue?

Phil Arnautou, Managing Partner at Colliers, worries that Silicon Valley’s current growth will be slowed down by the availability of technical talent. “The real problem is there aren't enough qualified people out there to fill the jobs to fill the buildings.”

Phil’s point drives home the other current theme of the Silicon Valley leasing world - it is all about the talent. Picking office space is no longer a tradeoff between rent and the distance to where the manager lives. Location decisions are both driven by, and constrained by how to attract new technical talent.
The next two years may see a slowing the Silicon Valley growth rate, but all indications are this is not a bubble, and this time it will not burst.