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Bubble 2.0?

Bubble 2.0?

For most of the U.S., the Great Recession was the worst economic stretch since the Great Depression. But for Silicon Valley, it paled in comparison to the wreckage the area experienced after the dot.com bust.

Dozens of hot up-and-coming firms that, mind you, were losing money hand over fist enjoyed rousing IPOs and entered the public's consciousness. (Remember Pets.com?) But many went belly up when the promises of future profits went unfulfilled.

As just one point of reference, during the Great Recession the Dow Jones Industrial Average peak-to-trough fell 53 percent. But the dot.com bust, in contrast, led the NASDAQ — which is dominated by tech firms — to lose 78.4 percent of its value from its March 2000 peak of 5,132.52 to its October 2002 nadir. Since then, the NASDAQ's highest point was 2,861.51 in October 2007.

The tech bust had disastrous consequences on the region's commercial real estate — particularly the office sector. Sprawling new suburban office parks ended up sitting empty. (There were tales — possibly apocryphal — of empty offices becoming popular skating parks.) At its worst, more than half the buildings in the market sat vacant and rents plummeted.

So it is with some trepidation that industry observers approach the latest round of technology mania gripping the region.

Tech firms are certainly growing again — and jaw-dropping IPOs have returned. This time, we're told, Silicon Valley start-ups like LinkedIn, Facebook and Twitter learned the lessons of the early 2000s bust and will show real profits.

The question that hangs over the region, however, is whether things are already becoming overheated. One of the curious dynamics that has emerged is that many firms have announced plans to go on hiring sprees in coming months, but the current unemployment rate remains high.

“I think this place will be jumping in six months, but that means a lot of hiring has to occur as opposed to being announced,” cautions Steven Levy, director and senior economist at the Center for Continuing Study of the California Economy. “And, it's important to note that the growth the tech sector is experiencing has not spread to other parts of the Bay Area economy, especially construction and government.”

Getting ahead of things?

As it stands, many economists believe the Bay Area (San Francisco, Oakland/East Bay and Silicon Valley) is on track to become one of the strongest regional economies in the nation, rivaling Washington D.C. and Texas.

By 2035, the nine-county Bay Area is expected to grow by more than 33 percent in terms of population and households and 36 percent in terms of employment, according to the Bay Area Council of Governments. The group projects that the region will add 2.2 million people, 835,000 households and more than 1.35 million jobs from the current levels of 6.78 million people, 2.46 million households and 3.75 million jobs.

However, job growth hasn't been terribly impressive. The region's job market has grown by 1 percent year-to-date, according to the California Employment Development Department. As a result, while the Bay Area's unemployment rate is lower than the rest of the state and compares favorably to the national figure, it is not a rousing picture.

The unemployment rate stood at 10.2 percent in the East Bay as of May 2011, while coming in at 8.1 percent in the San Francisco metro area and 9.9 percent in San Jose. During the same period, the overall unemployment rate for California was 11.7 percent and nationally it was 9.1 percent.

Forecasts for job growth and unemployment for 2012 to 2015 are far more robust. Various sources predict the Bay Area will achieve annual job growth of at least 3 percent, reaching 2007's employment peak by 2013.

But as it stands, more firms have announced intentions to hire than have actually expanded their payrolls.

Nevertheless, companies seem to be leasing new office space today, despite not necessarily having the bodies to fill those spaces.

“I think companies expect higher rents in the near future, and they want to make sure to take advantage of the rates today,” says Garrick Brown, research director for Terranomics, the retail division of BT Commercial in Sacramento.

That trend is also playing out in the retail sector where merchants are on the hunt for space despite the fact that job growth has yet to occur in any substantial way.

“Because they have already seen rental rates increase, they're willing to take the gamble and lease space now rather than wait six months when rates will likely be higher,” Brown says, adding that Terranomics' preliminary data indicates retail rents increased 5 percent to 10 percent during the first half of 2011.

Terranomics' preliminary data for mid-year 2011 indicates the market-wide retail vacancy rate for the entire Bay Area could drop as low as 5 percent compared to 6.8 percent at the end of 2010. “That number ranks among the lowest of all the major metro areas and translates into even more rental rate growth,” Brown adds.

Part of that is because the Bay Area has maintained its fundamental attraction — strong demographics and high barriers to entry, according to Jeff Berkes, president of Federal Realty Investment Trust's West Coast region. “The Bay Area got to the top of retailers' lists because it's home to a highly-educated workforce that is paid very well,” he explains. “That hasn't changed. And, the Bay Area is not over-retailed, so the market dynamics going into the recession were far better than the rest of the country.”

Federal Realty is so confident in the Bay Area's long-term potential that it decided earlier this year to dedicate more resources to the region. The REIT added several veteran leasing professionals to focus on properties throughout Northern California. In addition, the company currently has a 108-unit apartment project under development near Santana Row.

Concerns of another tech bubble

The frothiness in the market is causing a lot of concern that the Bay Area is setting itself up for another tech bust.

In June, The Economist conducted an online debate on whether the current activity in the tech sector is another bubble. Steve Blank, a professor of entrepreneurship at Stanford University and University of California Berkeley, argued that this was indeed the case, pointing to LinkedIn's IPO in mid-June which valued the company at $8.9 billion at the end of the first day of trading — roughly 572 times its 2010 profit.

“It sent a signal that there is an irrational demand for tech IPOs,” Blank wrote. “Silicon Valley startups are falling over each other to file their S-1 documents to go public. No one doubts that social networks and web and mobile applications are reinventing commerce. Obviously, some of these companies will have hundreds of millions of customers, unprecedented revenue growth and great profits. Yet none of these companies have earned the valuations that they are receiving.”

When The Economist debate concluded, the overwhelming majority of readers voted in favor of Blank's position.

Yet, there are still those that believe there are some differences this time around.

“The tech companies that are acquiring expansion space aren't just startups, they're companies with solid business plans and real revenue — companies like Apple, Microsoft and Google,” Levy says.

Still attractive

Among retailers, discounters and grocery stores are extremely active in the market and luxury chains are also grabbing strategic locations.

For example, Brown says that Grocery Outlet, a value retailer that operates more than 120 stores in seven western states, is looking to open five 20,000-square-foot stores in the next year throughout Northern California.

Most of the big-box space in the Bay Area that was vacated during the recession has been backfilled, and national retailers have such an appetite to expand in the region that developers are planning projects and moving dirt, according to John Cumbelich, president of John Cumbelich & Associates, an X Team partner based in Walnut Creek, Calif.

“For more than two years, retailers that wanted to expand were able to secure locations, and now that they have gone through the recession-created vacancies, that demand is being channeled into new development,” Cumbelich says. “We're at a point where our big retail clients absolutely have a desire to increase their presence, and we've clearly recovered enough to where the development cycle is ramping up again.”

Cumbelich says most new development projects are under construction or planned in the South Bay and Silicon Valley, where there is a heavy concentration of tech-related companies. In San Jose, for example, Hunter Storm LLC is developing @First, a mixed-use project with office, retail and hotel uses. Scheduled for completion later this year, the retail portion is anchored by Target.

In addition, the Cupertino, Calif.-based firm has proposed a 350,000 to 400,000-square-foot power center in San Jose. Dubbed Almaden Ranch, the project would have a price tag of $35 million to $50 million.

Beyond Silicon Valley, San Francisco's SoMa (South of Market) neighborhood continues to attract retailers and restaurants, according to Karen Hoke of Colliers International. “San Francisco is pushing south, and SoMa has seen the most residential and retail growth,” she notes. “The area also has become one of the most sought after areas for tech companies to locate.”

Westfield, a long-time property owner in downtown San Francisco, recently began development on Metreon, a $30 million redevelopment of an existing property. The project, located at Fourth and Mission Streets, just steps from the Moscone Convention Center, was put on hold due to the recession.

Slated for completion in spring 2012, Metreon will feature the city's first Target store. The new design will incorporate Yerba Buena Gardens and will feature an upgraded AMC Theaters, along with renovated event space. The redevelopment project is expected to generate $15 million in tax revenues annually, according to Westfield.

“Retailers and owners have a lot of confidence in the Bay Area,” Berkes notes. “There's an expectation of a lot of hiring in the tech sector, and those jobs will be highly paid, which will trickle down to the retail sector. The frosting on the cake would be if we see some of the bigger tech companies go public and there is a liquidity event for the employees. That will ratchet things up.”

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