SoMa Startup Influx Brings Fast-Rising Rents

One can gauge the health of the startup economy by poring over venture funding stats.

But a far more simplistic approach is to walk around the neighborhoods that startups favor, and see how much prime office space is still for rent.

Based on a recent trip through San Francisco’s entrepreneur-heavy South of Market (SoMa) district, followed by calls to several local landlords, it’s clear that the cycle has turned. Buildings that were plastered with “for lease” signs during the depths of the 2008-2009 financial crisis are now conspicuously occupied. And the tenant mix is heavily tilted to 20- and 30-somethings with a penchant for open plan, brick-and-timber office space and access to trendy cafes and restaurants.

“The vacancy rate has been dropping at an accelerating pace, and a lot of the best space South of Market has been taken,” says Jim Ellis, managing principal of Ellis Partners, a commercial property developer which is one of the larger landlords in the neighborhood. Rents are rising, as well, up about 40% from post-financial-crisis lows.

That said, the price-per-square foot in the most sought-after buildings is still only about half the price it was at the peak of the dot-com mania a decade ago. And new tenants, while willing to spend for a location they believe can attract top talent, are less likely to be paying the rent with venture capitalists’ money.

“This to me is really very different from the 2000 bubble,” Ellis says. “These companies all have for the most part pretty viable business plans. They actually have top line, and they actually are producing cash.”

Landlords are in a position to know something about the financial condition of their tenants, too. The lease process involves due diligence that is probably a bit more rigorous that what we’re hearing is going on in some angel funding rounds. And, while it’s not standard practice, the landlords sometimes are known to take equity stakes in the companies to which they rent space.

Granted, they don’t usually get a hit. Greg Flynn, a San Francisco commercial property owner who I interviewed over a decade ago when he was making his way as a “venture landlord” says he had stock in many of his tenants, but didn’t make any big returns. Still, as most were paying top rents anyway, the stock was more meant to be “icing on the cake,” he says.

Others had more luck. Michael Covarrubias, CEO of San Francisco-based real estate developer TMG Partners, for instance, rented space to Salesforce.com years ago, and had a stock position in the company that turned out to be quite lucrative.

Not everyone goes along, however. For instance, TMG is the landlord for what’s been reported as the largest SoMa lease in recent years, renting about 270,000 square feet to Zynga. The company, which has been profitable for a few years, wasn’t looking to sell him shares, says Covarrubias who adds: “But you can bet I asked.”