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The 2001 Bubble Bust: Is San Francisco's Decline Around the Corner?

May 12, 2015

 

San Francisco office spaceThe dot.com boom in the late 1990's and 2000 was organically generated as a new way to socialize and interact with one another across the globe came into existence. I'm referring to what we know today as The World Wide Web. Back then, no one knew what products and services would be accepted and become profitable identities using online websites. These early days of Internet commerce was uncharted territory. Firms were financed with the goal not to necessarily become profitable, but to grow their baseline brand and then build out a healthy customer base.

I remember asking a number of firms back then, "Where will your revenue come from?" Some firms would respond that they hadn't figured that out yet and that they were more focused on drawing in more "eyeballs" to their website.

Ultimately, most of these firms did not become profitable and closed up shop. Some firms were early adapters who saw their initial idea take off and be included as additions to other websites and services.

It was an exciting time that changed the way we live today. It was also a time that jump-started a major commercial and housing boom in our city. We had just come off a long and quiet office market, which had hit its all time low after the detrimental 1989 earthquake. The dot.com boom allowed San Francisco to transition from its tired warehouses to new ones, while allowing for more renovations and new office products. This would not have made economic sense if it weren't for the rent jump that occurred during this cycle. Without a steep rental increase, San Francisco would not have been able to upgrade its individual building stock, nor upgrade its infrastructure, which supports these buildings on a daily basis.

The rent jump that occurred also had a dramatic and negative effect on conventional businesses that existed to make money. Unlike tech firms today, these businesses had no financial investors who would allow them to exist without making a profit. Our core businesses today are faced with devastating rent increases that are not only clearing out potential profits, but also forcing businesses to relocate and eventually close business in addition to accruing tremendous added costs.

Predictions for our tech bubble today have said to be different in regards to tech firms. VCs are supposed to be more prudent in their investment strategy. However, as the market has once again expanded, the reality is that VCs are actually losing their investment strategies by supporting firms with very weak business models and more importantly, have an unlikely future for profitability.

Again, today I find myself hearing the same response when I ask firms if they are profitable or at least near profitable. "No, we are not profitable," they say. The question I typically follow up with is, "What range of revenue does your company have?" The response I receive is typically "We have little revenue at this point since the focus from our investors is to have us build out our business platform while increasing our customer base."

This strategy will work for some firms, but most will not survive. This may be acceptable for VCs who finance these firms. VCs don't need to have all of their firms be successful, just a select handful that could become the next Twitter or Google. However, for San Francisco's overall business community, this is not a sound strategy to control costs and allow for current profitable firms to succeed.

Critics may say that tech growth allows for all of our conventional firms to grow as well. In some sense, this is true. However, when rents are doubling or tripling for most businesses that have an expiring lease, they will have to see a similar growth in earnings in order to pay for added rent costs. The reality is that this is not happening.

In addition, these firms are competing with technology firms that don't have to necessarily make money. This means conventional firms are already operating at a serious disadvantage while competing for space in this very constricted market.

Something has to give. The last tech bubble had busted around March 2001, caused by a stock market correction. Prior to that cycle, much like today, new start-up firms were poorly positioned to succeed. Yet, office rents still increased and had ultimately hurt conventional businesses and their bottom line. When the crash hit, it not only took tech firms down, but also formed a major recession for the rest of our city.

Only the future will tell, but history does have a tendency to repeat itself. For now, it's best we enjoy this boom and prepare for a potential bust, even if it is years down the road.

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Written by: Hans Hansson

E-mail: hans@starboardnet.com


Hans Hansson is President of Starboard TCN Worldwide Real Estate Services as well as a member of the Board of Directors for TCN Worldwide Real Estate. Hans has been an active broker for over 30 years in the San Francisco Bay Area and specializes in office leasing and investments. If you have any questions or comments please email hans@starboardnet.com or call him at (415) 765-6897. You may also check out his website, www.commercialspacefinder.com.

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