222 Second Street 2016

Back in 2014, when LinkedIn pre-leased the entire 450,000-square-foot building at 222 Second Street that’s slated to open its doors later this year with room for up to 2,500 employees, its stock was trading around $175 per share.

As a plugged-in reader wrote at the time:

“For tech companies right now the 2 constraints are (1) hiring top people and (2) having enough [real estate] for their forecast-ed growth.

It may be a statement of the obvious but with the tech stock market where it is right now, projections of revenue growth and staff growth are very high and linked together. i.e. you cannot tell your growth story to the equity market if you cannot control enough [real estate] in job centers.

If you are in the SF office business, you have to buy into this equation, because that is what there is in SF — there is no diversified tenant mix for hi rises like there is in NYC or London. It is a concentrated investment and you are essentially a supplier to a narrow swatch of social-networking industry.

The big question is – or will be – when the stock market in tech falters – what happens to hiring, growth projections and all the excess space that is being defensively leased right now.
There is, conservatively, 5 MIL sq ft of office space under lease / LOI etc that will not be “occupied” on initial tenant occupancy in SF downtown / soma. call it shadow vacancy even if it is not on sublet market.

Is it different from last time because twitter and square and airbnb and uber are long term different from b2b or webvan or scient or yahoo or jdsu etc.? Time will tell.

Right now the answer is the one you want it to be, and clearly 95% of investors in [commercial real estate] want it to be “different this time.” But I would really, really hedge an all tech portfolio.”

Last week, LinkedIn shares plummeted over 40 percent. And with a recovery day now closed, LinkedIn is currently trading at $110 per share, roughly 35 percent below the price when the company inked its growth-story lease.

And a back of the envelope calculation would suggest that up to two-thirds of the company’s 9,000 employees, a third of which have been added since 2014, are effectively out of the money, or even underwater, on any options or purchased shares.

On a positive note, when LinkedIn inked its 222 Second Street lease, the average office rent in San Francisco was around $57 a square foot, roughly 20 percent lower than today. But that’s still an annual lease payment of at least $25 million a year for the building, or a significant amount of previously committed tech space which could suddenly become available.

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Comments from “Plugged-In” Readers

  1. Posted by RobBob

    Do the majority of LinkedIn employees even get options? As I understand it for publicly traded companies only executes now receive options (basically, those that received qualified options still receive qualified options), but the majority if not all of the employees who used to get non qualified options now get stock grants instead. This is due to some tax related rulings that the IRS made where companies need to pay taxes on the market value of the options given out.

    • Posted by moto mayhem

      depends on the size of the company. many young companies give options to everyone, even years after they are public. many mid-size established but growing companies give a combo of RSUs and options. Most large older companies with little growth give only RSUs

    • Posted by brooder

      RSUs are the currency of the day, not options.

      • Posted by moto mayhem

        dont agree with that. it depends. most young, growth and non-profitable companies give options instead of RSUs

        • Posted by RobBob

          People with large numbers of options in non publicly traded companies have an asset that is difficult to convert into cash without an ipo.

    • Posted by ess

      Generally a public company will give RSUs where a private company would offer options. Public companies may also have ESPPs where employees can buy stock at a discount.

  2. Posted by moto mayhem

    Are they actually pulling out of the space?

  3. Posted by MysteryRealtor

    So, they can sub-lease and still make money?

  4. Posted by Nimby

    This post is a lot of speculation! So far, LinkedIn hasn’t given any indication of giving up the new space. When I talked with an employee about this some time back, the rationale for the new space involved consolidating their offices in SF (2 separate locations, plus future SF-based acquisitions). On a smaller level, some teams also wanted to move to SF from the South Bay.

    • Posted by SocketSite

      Actually, there isn’t any speculation in our report above. There’s one estimate (that two-thirds of LinkedIn employees have never seen a share price this low), and the rest is fact.

      If it’s simply a consolidation play, that’s up to 450,000 square feet of other space in San Francisco which will soon be vacant. And in terms of acquisitions, the 40 percent haircut is going to hurt.

    • Posted by two beers

      “This post is a lot of speculation! ”

      Oh, the irony.

  5. Posted by SFRealist

    Even after getting hammered, LinkedIn’s market cap is $14 billion with apparently $600-800M cash on hand. I think it can handle $25M/year.

  6. Posted by Some Guy

    Certain tech companies are here to stay, ones that have really radically revised their market dymanics, like Uber and AirBNB. They are not pie in the sky fool’s games like Webvan, they are generating real revenue with innovative and heretofore inaccessible methodologies. But yes there are plenty of lame unicorns who will probably shake out and die out in the next few years. Maybe even twitter, everyone likes to tweet but where’s the money in it?

    • Posted by Sabbie

      Those companies are the exception not the rule. There are about 150 unicorns right now, if you look through the whole list you’ll be shaking your head.

      • Posted by Brian M

        It seems like so many tech companies are aimed at providing unneeded services to a slice of the urban upper middle class. Ephemeral services. Like, it is just so very very onerous to have to actually hand a credit card to a sales clerk when I instead can wave my cell phone at a machine reader! Sure, it’s a cute service, but is it worth the amazing amount of capital thrown at it?

        • Posted by San Fronzischeme

          Credit card transactions are paid through an interchange system. I once worked on a project to cut one middle man for a smallish local CC processor (<1000 high value point-of-sales). The ~0.5% he saved amounted in something to the range of $1M/year. The streamlined transactions matter a lot to capture more merchants and this can be reflected in significant profits.

        • Posted by moto mayhem

          yes, theres tons of money taking out the middle man, when you have millions of transactions

          • Posted by heynonnynonny

            Yeah, but nobody’s trying to take out the middleman here. Lots of companies trying to become the middleman is more like it.

          • Posted by San Fronzischeme

            Actually that’s not entirely true. When I worked for this CC processor (let’s call it Company X), they had the following set-up:

            – Merchant PoS marketed directly by Company X
            – Transactions from PoS going to a processor (later handled by Company X, following our work)
            – Processor has proprietary servers in-house with connection to Visa
            – Visa box processing MC, Amex, CB, Diners, JCB through communication with CC issuer
            – Back-end processing done by Company X, forwarding chargebacks and communications to the CC issuers

            There were a lot of inefficiencies. A new player can manage to save on:

            – In person Marketing (people jut sign up directly)
            – In person set-up (easy and self-explanatory)
            – Data processing (communication goes directly to a larger entity dealing directly with CC issuers)
            – Back end processing happening directly at this new processor. Almost no human involvement.
            – Scale effect that a company with 1000s of PoS can have in the interchange fee

            It’s all about streamlining, saving at every step, doing economies of scale.

    • Posted by anon

      Uber and AirBnb?

      Beware the hype machine my friend. Those product categories, on demand cars and rooms, are here to stay, but companies can rise or fall for many reasons while product categories march on.

      Webvan’s a great example. You have plenty of companies offering grocery delivery today, but Webvan the company is completely defunct.

      Neither AirBnb nor Uber have unique product offerings. Personally, I’ve found AirBnb quite inferior to say VRBO. Uber, I feel, has a best of breed iOS app. But I find nowdays that nearly all of the drivers I get work for both Uber and Lyft. So the actual service I receive is essentially a commodity.

      Both Uber and AirBNB burn cash, have sky high valuations and have nothing that really makes a customer “sticky”. i.e. Switching from Windows in the old days was incredibly hard for an organization, so customers essentially got stuck with a high barrier to exit. Switching phones is irritating with apps and media purchases being somewhat tied to a platform. But if I Uber one day, then Lyft the next it’s no skin off my back.

      Currently they both have access to huge amounts of funding. But that money is no gift. Investors will expect quite a bit in return. Webvan was very well funded in its day.

      And technology marches on. Building Uber might have been a technological feat in 2009, but in 5 years college kids will be throwing together car share apps as school projects.

      Again, look at Webvan. Might have been high tech for it’s time. But now Safeway!! has grocery delivery. And I really doubt that the top coders from MIT are lining up for IT jobs at Safeway.

      • Posted by Some Guy

        These are all very good points, thanks.

      • Posted by cwilly

        Well said

      • Posted by San Fronzischeme

        Airbnb and VRBO bring lots of efficiencies in what used to be a very inefficient business. No-one who has used their services is ever going back to Craigslist.

      • Posted by no_ vally

        Webvan actually lives on…one obscure bit of tech trivia is that Amazon acquired all the Webvan assets, systems and IP, so in many ways Webvan was just rebranded as Amazon Direct. Webvan simply got ahead of itself from a cash burn and build-out perspective as the tech funding market froze in 2001…but as Amazon has now proven, it was always a great idea.

        • Posted by two beers

          In other words, Webvan is still losing money. Amazing.

  7. Posted by BTinSF

    I wouldn’t worry about the options. If it’s clear they are underwater to stay (at least for a few years) they’ll reprice them. That’s what most of the survivors did in 2000.

  8. Posted by NOPA

    So…other than stock price fluctuations, do we have any indication companies and downsizing their real estate foot print? I have read some companies are subletting more, but it seems like the market is just reaching a plateau.

    The real signal would be developers delaying or putting projects on hold. I’m not too worried. Yet.

    • Posted by two beers

      This is how it starts, it’s just the beginning. Bubble’s never, ever “plateau” or level off. They “correct”, and hard.

    • Posted by moto mayhem

      one differnence in this potential fall vs. 2000, is that the companies now have way more cash on hand than did those in 2000. They can survive longer in a downturn.

      • Posted by two beers

        In a down-turn, would you expect cash-rich companies to try to stem losses and hang on longer, or to continue splurging like there’s no tomorrow? If you expect the latter, please mention the school where you got your business degree, so we can give credit where credit is due. if the former, what will the effect be on local RE? Isn’t that the important question to people whose livelihood is tied to RE? Or is it better to whistle past the graveyard?

  9. Posted by Dave

    If its true there is 5 million square feet of defensively leased space in SF that could present a problem.

    Are there numbers on the amount of sub-lease space on the market. Has Schwab’s space at the Fremont/Mission tower been taken yet?

    One thing in the quote above, SF no longer has the diversified tenant mix it once did but it more than just social-networking companies the SF market caters to.

    • Posted by anona

      If its true there is 5 million square feet of defensively leased space in SF that could present a problem.

      How? Once square footage is built there’s no problem. The “problem” might be lower than highest in the country leasing rates? Ouch, big problem. We might have to deal with companies other than tech moving back.

      • Posted by two beers

        The problem is that many other companies have left the area because the cost of living, driven primarily by the cost of housing, has skyrocketed. RE prices are very sticky on the way down, for many reasons, one being that RE is an long-term asset and not merely a price-discovering commodity. Other sectors aren’t going to rush in to fill the vaccuum until RE costs make sense, i.e. until mean reversion brings costs more in line with other urban centers.

        This is why many of us have been screaming about the gutting of PDR space in SF: it guts stable,well-paying working class jobs and puts all the city’s economic eggs in one speculative basket. Millions of square feet of workspace dependent on ephemeral disruptive-on-demand-leading-edge-scalable-cross-platform-cloud-based-pizza-delivery apps that a teenager in New Delhi could write in a few weeks. What could possibly go wrong?

        • Posted by moto mayhem

          how many companies moved out of town. How many jobs did they take? the net influx of jobs and companies is MUCH greater

        • Posted by anona

          I’m still not seeing the problem? If what you say is true then we’ll just see prices fall even farther before stabilizing.

        • Posted by curmudgeon

          Relatively few companies moved out of town. Many of those that did moved to Oakland, which frankly helps the region. I suppose there has been a long term drain of jobs at Schwab and Wells and a few other HQ firms which have “right sized” by expanding back office and some other functions outside of the Bay Area, but frankly that’s been going on since the 80’s anyway. Screaming about PDR space does relatively little to preserve anything.

    • Posted by moto mayhem

      there is still a very diversified tenant mix in SF. what are you talking about?

      • Posted by Dave

        I was referring to the quote in the post saying that and I was disagreeing with it..

  10. Posted by Jimmy The House Flipper

    “The market has reached a permanently high plateau.”

    • Posted by Stop Driving

      I wouldn’t take financial advice from someone who uses the terms ‘market’ and ‘permanently’ in the same sentence.

      • Posted by anon

        You should google the phrase to understand his reference above.

    • Posted by Hibernatus Ursus Majorum

      “Scare tactics are dead. Home prices in San Francisco have never taken a hit and they won’t ever”

  11. Posted by not drinking the kool aid

    Not to mention the regulation and that AirBnb and Uber will have to grapple with moving forward. Airbnb is just a platform but fighting against all the regulation. It’s no different than an online travel agency with less supply and less revenue per transaction and more regulation to fight moving forward. But other than that it totally worth bizillions.

  12. Posted by Stop Driving

    If you don’t understand the cyclical nature of the game, you should play elsewhere. These cycles are painfully obvious to anyone who has watched long enough.

  13. Posted by Dave

    That is an awful looking building. How did it get past planning? Oh yeah, this is SF.

    • Posted by The Milkshake of Despair

      Kind of looks like a vertical version of the NSA HQ in Fort Meade.

    • Posted by SFRealist

      It’s kind of sad, but I walked past there this weekend and was actually impressed that it got past planning. Isn’t that the building where the windows aren’t flat on the surface but are at an angle? I was surprised that planning didn’t force them to be just flat. By our standards, that qualifies as edgy.

  14. Posted by Armand

    One of the major brokerages just published a report placing the amount of SF office sub-lease at 3% of the market. I feel it is higher but that’s the only data point I came across.

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