Silicon Valley startups lease offices close to the action despite high rents

Finding office space may not be the sexiest aspect of starting or running a company, but choosing space where you’re close to the people and firms you want to collaborate with and where you can find the kind of talent you want to hire is critical.

That’s why we’re seeing so many tech startups focus in on two of the Bay Area’s hottest commercial real-estate markets — San Francisco’s South of Market (SoMa) District and Silicon Valley’s Palo Alto. The prices might be high, but many tech startups are willing to pay the premium to be close to the action.

Palo Alto and SoMa landlords couldn’t be happier with this tech boom. Vacancy has plummeted in these two markets. Palo Alto, which is more supply constrained than its northern counterpart, has 5% vacancy, and landlords collect as much as $70 a square foot per year ($6 per square foot per month). The South of Market district is growing faster than any other market in San Francisco, demanding rates that surpass rates in some Class A buildings in the Financial District at $40 per square foot per year on the high end.

Many of my clients want to be close to the action and will pay a premium to be there, but startups can manage the expense by staying lean.

Naval Ravikant, of AngelList and Venture Hacks, says keeping your startup small gives you the ability to locate in SoMa and Palo Alto at a higher rate per square foot. “I think the nature of the market is such that (a) most of these new companies are smaller than they used to be and (b) recruiting is the hardest and most important thing for them. Therefore, they’ll pay a premium for pretty small spaces close to other startups, BART, and Caltrain, and will be less price sensitive, per square foot, than companies have been historically.”

Krutal Desai, founder of Sponge, a question-and-answer service for businesses including Mint.com, opened his first office on 2nd Street in SoMa and says he wants to stay there even as rents go up. He cites the close proximity to his venture partners and fellow startup founders. While many of his employees come from the East Bay, he wanted them to experience the environment of SoMa and feed off the competition and work ethic of the other startups.

There are many startups with offices in the area, which makes it easy for out-of-town investors, business partners, media and recruits to visit several companies in one trip. Also, as some startups fail or contract, the talent pool will constantly replenish.

Although opportunities abound in nearby markets to South of Market and Palo Alto, technology-based companies have in large part been reticent to venture out of these areas. For instance, while Palo Alto’s vacancy hovers around 5% on a direct and sublease basis, Mountain View has a 15.9% overall vacancy and San Jose’s Central Business District has more than a 26% overall vacancy.

Similarly, although less polarized, the South of Market Financial District has less vacancy than its North of Market counterpart, 10% and 15% respectively. The red-hot South Beach and Rincon Hill sub-markets of SoMa (near the ballpark) is 12.1% overall vacancy and shrinking every quarter.
Tech tenants have yet to significantly penetrate North of Market. Landlords in the Financial District, Union Square, Civic Center and Jackson Square hope to court tech tenants to their spaces with generous improvement packages and cheaper rents.

Granted, some companies are capitalizing on the cheaper deals in Union Square and North of Market in San Francisco. One of my clients, Ryan Merket, CEO of AppBistro, the biggest online marketplace for Facebook apps, just opened his headquarters in Union Square. “We have a great space with hardwood floors, large open area, conference rooms, tons of natural light and the amenities are great. We looked at countless spaces in the city, and we are paying a fraction of what we would be paying in SoMa.”

I can’t speak to the exact terms of the deal, but the same space in South Beach would have cost 40% to 50% more.

However, 2011 will be a big growth period in the tech sector, and the tremendous activity in South of Market and Palo Alto will begin spilling out into their neighboring markets soon.

Justin Bedecarré is a real estate advisor for technology and media companies at Cushman & Wakefield, a commercial real estate firm covering the Bay Area. He has represented firms from Fortune 100 to startups in media and technology, including Broadcom, Thomson Reuters, AKQA, and Hearst Corporation, to name a few. He writes a blog on the intersection of technology and commercial real estate at www.BayAreaComRE.com. He can be reached via email at justin.bedecarre@cushwake.com or at About.me,@jtbed on Twitter, Facebook, LinkedIn and Quora.

[Image credit: Scott Shiller]