How Startups should manage commercial real estate during Covid

Eli Ceryak of Cushman & Wakefield - Podcast Transcript

Scott:	Hey, Scott Orn, Kruze Consulting and welcome to another episode of Founders and Friends. And before we start the podcast, let’s give a quick shout out to Rippling. Rippling is the new cool payroll tool that we see a lot of startups using. Rippling is great for your traditional HR and payroll. They integrate very nicely, but guess what? They did another thing, they integrate into your IT infrastructure. They make it really easy for when you hire someone to spin up all the web services and their computer, which sounds like not a huge deal, but we did a study at Kruze. We spent $420 on average, just getting a new employee’s computer up and running and their web servers up and running. It’s a really big deal, saves a lot of money and the dogs are in the Dogwood. We see a lot of startups coming in to Kruze now using Rippling. Please check out Rippling, great service, we love it. I think we have a podcast of Parker Conrad, you can hear from his own words, but we’re seeing them take market share. Shout out to Rippling. And now to another awesome podcast at Kruze Consulting Founders and Friends. Thanks.
Singer:	(singing) It’s Kruze Consulting Founders and Friends with your host Scotty Orn.
Scott:	Welcome to Founders and Friends podcast with Scott Orn at Kruze Consulting. And we have a really awesome podcast with Eli Ceryak of Cushman Wakefield today. Welcome Eli.
Eli:	Hi Scott, how are you doing?
Scott:	Good. This is the third time on the pod. I think only two or three people have ever been on three times. This is the ultimate validation. I know you’re going to go home and tell your wife later today.
Eli:	Exactly. I think I did, I think the second time I was on, I mentioned ahead of Evan Mauer, but I think he figured that out and I think he’s now several ahead of me. I’ve got work to do to catch up with him.
Scott:	He also did the theme song, he’s tough to beat.
Eli:	That’s fair. I have no musical talent, Evan deserves that.
Scott:	But you do know real estate and that’s what we’re talking today. San Francisco, Silicon Valley, and really the startup real estate ecosystem in general. There’s a lot of crazy stuff happening right now. We’re taping this in middle of June with COVID going, seems like COVID second wave coming right now. But what’s your quick read on the real estate market and then we’ll get into some very specific questions.
Eli:	I’m based in San Francisco, work primarily in San Francisco, but also work throughout the Bay Area and have clients in other markets as well. As you know it was middle of March when we shut down for the pandemic. We’re now three months in and San Francisco in particular are very slow to reopen. And that’s been very true of the commercial real estate market as well. There were a handful of things that we were working on when pandemic hit. Some of those we’ve powered through and got deals done and are opening up new offices for clients. But for the most part things are shut down and there’s a lot of sublease space that’s on the market and there’s just not a lot of touring activity. There’s not a lot of deal activity. In many ways the commercial real estate market is essentially shut down.
Scott:	Yeah. When you say shut down is it because the gap between buyers and sellers quote unquote is huge? Or is it just people don’t want real estate at any price? It’s hard for me to tell what’s really happening under the surface.
Eli:	Yeah. I think to the extent people have leases expiring or need to make decisions they are. And then to the extent, a couple of the leases we completed recently, one was with an online gaming company, it’s a very solid business and their business has not been negatively affected by the pandemic. And there was another lease that we finished recently with a cyber security company, which is a startup that’s doing very well and just raised a lot of money. Those types of businesses are still out there and taking space, but anybody that doesn’t have to make a decision right now, for a lot of people they are just putting things on hold. And I think part of that too, is people in San Francisco in particular have been in, this is both managers and employees, have been very reluctant to get back to work much more so than in some other regions where we have clients, where things have not been quite as dramatically as affected.
Scott:	Yeah. And again, we’re taping this in middle of June where it feels like the COVID numbers are creeping up across the country. We don’t really know probably by the time people listen to this, there’ll be a lot more clarity there. But it seems like why would you crowd into a wee workspace or a big office building or something like that, if you don’t have to. It just seems like a risk not worth taking to me, at least like Kruze, we’re remote anyway so it hasn’t really been that huge of an issue for us. But we’ve told our San Francisco and San Jose teams that they can just work from home indefinitely. I know there’s been a lot of companies trying to get out of their leases too, whether it’s because they don’t want their employees to come back to work because of health reasons or just because they have cut their burn rate. What are the tactics and what are you seeing in that aspect?
Eli:	Yeah. And there’s a couple different things I’ll hit on there, Scott, before I address getting out of leases just wanted to make a point about people not using their offices. One thing is for the most part, there are very few companies that are saying we are going to go 100% remote as a result of that. I think almost everyone has realized that remote work can be very effective and there’s probably some people that can do remote work full time. But I think for a lot of companies, even if they’re going to give their employees more flexibility, they still want to have a physical footprint. We aren’t seeing… We’ve had a handful of clients and they tend to be smaller teams, 10 to 15 people or less, that have figured out that remote work is fine. They prefer to save the money by not having an office and they feel like the work can get done. I think for bigger organizations, it is still pretty critical to have a physical footprint, even if they may not be using that physical footprint for the next two or three months, or maybe even not for the rest of the year. There’s that dynamic that’s going on. It’s not like demand has completely 100% disappeared. There’s just not really new demand and a ton of new tenants coming into the market.
Scott:	Yeah. Also, on the demand side, that seems like a lot of companies wanted to enable the drop in quote unquote drop in, where they visualize their employees working from home a couple of days a week and then working from the office a couple of days a week. And I haven’t read anything online where people are talking about… I haven’t seen a really good structure for that. Like, we’re going to rotate every other day, certain people or things like that. It seems to be laissez faire right now. But it seems like that is where things are going, where people are going to have a drop in culture or maybe you meet the same days as your group meets at the physical office a couple days a week and then the rest of the time you can do whatever you want to do.
Eli:	Yeah. I think that’s right. And since the dawn of the internet, 25 years ago, we’ve been talking about remote work and teleworking and that you wouldn’t have a physical desk at your office, you would just show up and it would be more of a hotel and type situation. But most companies we’ve been talking about that for 20 or 25 years. And it’s only happened now because it was basically forced upon us.
Scott:	Needed.
Eli:	And I do think we are going to see a lot more of that going forward, where there is a lot more flexibility built in for companies.
Scott:	It makes sense. It’s also maybe a generational thing where we have, my wife is a millennial. We have a lot of millennials that work at Kruze Consulting and that age bracket really appreciates flexibility. That was one of their core values. And that could be a function of that too, whereas people who grew up working in more traditional office environments like myself, I’m 43 now, as we get older, the millennial workforce replaces us and there may be more people who value that flexibility.
Eli:	I’m also 43 and I’ve always been a I need to be in the office kind of person and I’m going to be more productive in the office. And I think there’s a lot of truth to that. But having been forced to work from home for the past few months, I’ve realized that there is a lot of work that I can get done at home that I just never realized before. And maybe going forward, I’m a person who’s in the office three or four days a week and works from home one to two days a week.
Scott:	Yeah. I think that’s going to be me too. I like the structure it brings. Hey, we’ve got a couple of topics here to talk about. The first one you brought up before I turned the mics on which I love, I think this is really interesting, which is the dichotomy between urban and suburban real estate markets, office real estate, maybe you could talk a little about that.
Eli:	Sure. For the tech boom for the last 10 years, San Francisco was a huge beneficiary of that. It was very different from previous cycles where I would say two thirds of the tech growth that happened in the Bay Area happened in San Francisco in this last cycle and maybe a third was down in Silicon Valley. In the past, that was reversed. Sometimes you’d have startups in San Francisco, but they would get to a certain size and they would undo their Silicon Valley campus. And that, the idea of an urban campus became popularized during in the last 10 years and a lot of that was around millennial workforce. People in their 20s and 30s wanted to live in cities, wanted to work in cities, but also all the good things about living in cities, the restaurants, the bars, the culture, dating circle of socializing. And that really shifted in the last 10 years and San Francisco really benefited from that. But it seems like we’re going to see a shift now where frankly, there’s just a lot of things about, as long as we’re in a pandemic suburban office seem safer. You can drive, you’re interacting with less people on the way into the office. And activity has been very slow to pick up in San Francisco, it has picked up in Silicon Valley, it’s picked up in some other suburban markets and part of the country as well. And I don’t know if that’s going to be a permanent shift, but I do think for the next year or two, that places like San Francisco will struggle compared to places like Silicon Valley or other more suburban style markets.
Scott:	Yeah. You nailed it. When I started my first in 1999, I was working at Hambrecht & Quist became JP Morgan. But everyone else who worked in finance or venture capital or something like that was that related to startups was working in the Valley. And then in 2002, I started working in the Valley and I commuted for nine years. I can’t even imagine what my 20s would’ve been like if I could have just worked in the San Francisco the whole time. I was driving down the Menlo Park and back every single day, except for Fridays, I worked at home on Fridays, for nine years. The culture really did shift quite a bit. We’ve been looking for, to hopefully buy a house at some point and our real estate agent has been telling us that houses in Marina and the East Bay are selling really quickly whereas the San Francisco market seems to be frozen for residential real estate. And our residential real estate person was saying he thinks it’s because people want to get out of the city and they want to have more space and especially if there’s more shelter in place kind of stuff and have a backyard and things like that. And if consumer preferences switch that much, then of course it’s going to reverberate back into the office market. And it sounds like that’s what you’re seeing a little bit too.
Eli:	Yeah, absolutely. And the San Francisco office market, we have seen a ton of sublease space hit the market. There’s now 40% of the space that’s available in San Francisco is sublease space, 40% is sublease, 60% is direct through landlords. Typically, that’s 15 to 20%. And that trend was already starting to happen pre-March, pre-pandemic. The trend was starting to happen because San Francisco is expensive that a lot of the tech companies that were here were already starting to sublease space and move to places like Denver or Austin or Phoenix or Nashville where rents are more attractive and labor’s cheaper and also your workforce can afford a nicer lifestyle with the same salary or with a smaller salary. We’ve already seen that trend pre-pandemic of companies starting to leave San Francisco or shift certain jobs out of San Francisco. And then with the pandemic we’ve seen a lot more. San Francisco has been very hard hit, and there’s not nearly as much sublease space in Silicon Valley or the East Bay or farther out in Sacramento as a percentage of the market. We will see more in all those markets, but not nearly on the same scale that we’re seeing in San Francisco. And that’s going to drive price rate up.
Scott:	That’s crazy. And also San Francisco has the gross receipts tax and the SF payroll tax. There’s a lot of taxes that you have to pay if you have a huge workforce here, any workforce, but really if you’re workforce is big. It already made, like you said, we saw a lot of companies last year in 2019, moving to Austin or putting a big call center or customer support team in Phoenix or things like that. There’s a lot of companies moving into Denver. We see the same thing you’re saying. I don’t know, it’s getting crazy. I’m still a long term bullish because this is the third cycle of people moving out of San Francisco that I’ve seen. I started my career in 1999 and in 2001, it was a ghost town, 2002 ghost town and slowly built itself all back up. In 2008, it got really quiet too. And for a couple of years it was really quiet. And then a bunch of these good companies were started in San Francisco because partially the real estate was so cheap and you could get a startup office really inexpensively. And it seems like this is the cycle of the city and we have a boom and bust city. I’m not really that phased by it, but for some companies it’s really tough to get out of your leases, it just always is. And for others, it’s going to be a pretty big opportunity, I think.
Eli:	And to go back to you, asked the question earlier about getting out of your lease. And the reality is almost all commercial leases are written so that if there’s no out clause for a pandemic, but landlords and people who write insurance policies are very good at figuring out the, I think everybody learned in the last few months that you’re somehow business interruption insurance, which seems like it would be for exactly this scenario, all seems to have a pandemic exclusion.
Scott:	Oh God. Really? Oh my God, I didn’t know that.
Eli:	But commercial leases, the concept of just breaking your lease and walking mid lease is something that you would want to be probably not do at all. Definitely be extremely cautious and absolutely consult an attorney, if you’re going to do it because there are credit risks and other risks that go along with defaulting on your lease. There are a lot of retail tenants in particular some of them are simply not paying rent and some of them are working out deals with their landlords, but you need to certainly consultant an attorney and definitely have a dialogue with your landlord before you start trying to do anything. Because a lot of times the risks can outweigh the potential benefits.
Scott:	I think let’s get into that a little bit, because I’ve had a few people ask me this and your lease is unsecured debt. It is debt, you’re on the hook. There’s no getting out of that. And even people maybe don’t want to pay or whatever, but they’re effectively a lender to you and they can take you all the way, they would have to team up with a couple other people who you owe money to put you in bankruptcy, but they have some real ramifications. And you do have to work with your landlord and just can’t get out of it because you don’t want to pay that’s… You need to be more mature than that. There is one, we were joking around before we got on because there is a catch phrase that’s come up, which is blend and extend. And maybe you can, you can explain what that means to the audience and if you’re advising any of your clients on it.
Eli:	Sure. Blend and extend was a… I started my career in the Bay Area, similar to you in, I started in 2000 and I got into real estate at what I thought was the dot-com boom, but very quickly figured out it was the dot-com bust so you got to learn phrases like blend and extend. The concept of blend and extend is if rents have gone down and you have a little bit of time left on your lease, you can, let’s say you’re paying $80 a square foot and the market goes to $60 a square foot. The idea is that you would effectively, depending on how much time is left on the lease, you might do a new deal at $70 a square foot and lower your rent immediately. That’s the very oversimplified version.
Scott:	When you extend the time period of that $70, you’d give him another year or something like that.
Eli:	Yeah, exactly. And it depends on, there’s all sorts of factors. It’s what rent are you paying? What is the market? What is the market at? Even when your lease is up, there’s always a negotiation around between the tenant and landlord on what the market is at. There’re different views around that. And I think blended extend, it’s absolutely something tenant should be looking at. I do think in this environment, we don’t know because the markets have been, I wouldn’t call them closed, but because there’s been little activity, we don’t really have true pricing data and rents are going to come down and they’re going to come down, I think more over the, there hasn’t been a big price adjustment already. I do think if you were a tenant and thinking about a blend and extend, one thing to look at is in my view, you’re probably going to be a little better off, maybe a lot better off a few months from now than trying to strike that deal of the day. But part of that comes down to it needs to be personalized to each individual business. If you’re at risk of default or if your rent payments are really a major drag on the business. And if you’re having cashflow issues that you think are going to get better in the next few months, maybe you do strike a deal now because the immediate rent relief is more important. But if you have a little more runway, I would, on the tenant side, wait until the market’s opened back up a little bit because I’ll just share an example. We’ve done a few surveys for clients recently to clients that have leases up at the end of the year or early next year and just trying to get a sense of what pricing, what rents might look like for them. Any of the landlords that I call our landlord brokers that I call, it’s almost the same conversation every time. It’s the last deal we did before the pandemic was 95 bucks and we think maybe rents are going to go down 5% or 10%, but they haven’t even really lowered their rent yet. They’re just waiting for things to open back up. If you look at sub leasing, you can get pricing data on subleases because anybody that has a sublease space on the market just wants to get a deal done as quickly as possible. And they typically have it priced in a way that it’s going to move a little more quickly, whereas landlords have a whole building and if they lower their rent on one space, all of a sudden, they lower their rent for the whole building. And landlords are more reluctant to adjust pricing in most circumstances.
Scott:	I think that is [inaudible] than just talking the market up. They don’t want to have an inkling of weakness or else that’s when the dam breaks kind of thing. You’re right, you can’t really look to them to give you accurate pricing data. But the sublease data you’re talking about is probably has very few data points because there’s probably not too many people signing a sublease.
Eli:	Yeah. But you can get the asking rents. There’s good data. There are not a ton of actual comps in taking rents out there, but you can get the asking rents and that’s a start. But when we look at the, we’re still assuming that a lot of the asking rent data is going to come down, if somebody somebody’s asking $65 or $75 on a sublease, the deal’s not happening above that and it’s probably happening somewhere below that. That’s how you get pricing discovery on what the market might look like. I think we show our average rents in San Francisco right now are about $78 a square foot. They were $82 pre-pandemic so a slight decrease, but not a major decrease. But most of the subleases we look at, not all of them, but most of them are priced at $75 or less. And we think the actual transactions will happen below those numbers. Short answer for, if you need to go make a decision now as a tenant, do it and you’ll have a lot of bargaining power, but particularly for people that can delay the decision for a few months, you are going to have a lot more options and much better pricing.
Scott:	That makes total sense. That’s good advice. Because I wouldn’t think the deals would be getting done in the 40s or 50son subleasing, half price basically would be my short hand, because there just seems to be so many options, many people trying to cut space. But who knows, it’s such a one off and also the people who are listing these places, obviously a lot of times are working with the agent like you, but they’re also just like VPs of finances or controllers or someone at a startup who’s not who doesn’t really know much about real estate. They could just be listing things based on a discount to what they’re paying instead of listing it and what the true market clearing price is.
Eli:	Yeah, exactly. And I think the other thing is because activity’s still has not picked up that much yet. If you think the market clearing price is $45, if there’s no demand, it… The point of a market clearing price is you get a deal done. But if the demand is still not there, then there’s less incentive to put it out at that aggressive price. I have subleases on the market for a handful of clients right now when we’ve cut prices on a couple of them recently and we still haven’t had tours. I think we’re priced probably correctly, but it doesn’t matter if there’s no touring activity.
Scott:	Yeah. Oh my gosh. No one’s even looking at them. That’s crazy. Do you see this being a big shift into some of the other tech startup cities like, is Austin and Salt Lake City, 10 years from now going to start, maybe not exactly the same, but start rivaling San Francisco. It feels like the seeds for those cities’ greatness are being sown right now.
Eli:	I think so. And I have a couple of thoughts on that. One is you and I both been here long enough that we’ve seen these San Francisco’s bad and we saw it in 2000, we saw it in 2008 and a year or two later, it was booming and doing well. I think, you said this earlier, but San Francisco is one of the most cyclical real estate markets if not the most cyclical real estate market in the country. Our booms are really high, our busts are really low, but we’ll be back. I’m not worried about that. But I do think Denver, Austin, Nashville, some of these other cities that we’ve talked about, I do think they’ll benefit. And some of it is pandemic related and a change in how we work. But a lot of it is it’s just so expensive to live here and do business here. And that was the trend that we were seeing pre-pandemic. Cost of housing for example, is such a drain on so many people in the region. There are good reasons for that, there’s strong economy and it’s a great place to live. That’s part of the reason why housing is high, but we’ve also under produced housing in California for decades. And so that, as much as the pandemic and economic fallout is going to, in the long run, I think hurt us. And I think some of those other cities we’ve mentioned will benefit as a result. Hopefully we see changes in some of those policies. I think there’s a groundswell for that, but California which is so progressive in so many other regards, has just failed on housing policy for decades.
Scott:	Supply and demand. We just need to build more. Hey, do you have any parting thoughts? And maybe you can also just let the audience know how they can look you up. And before you do the parting thoughts, just want to give a quick shout out to you for being our agent for many years. Thank you for all the help and advice you’ve given us and not only do you find us new space every year as we are growing really fast, but you also helped us sublet the old space. Thank you for doing that. And there’s nothing more terrifying than having two sign leases as a startup. Thank you. I still remember those days we were trying to sublease the office by Union Square and I’m glad we got it done. If you’re a startup out there and you’re listening to this podcast, Eli is an amazing person to represent you and advise you in office real estate. And I do agree with him that people are going to need something. You may have maybe half the size or because of social distancing, you may go back to the same size office that we all used to have, but regardless, Eli is just a pleasure to work with.
Eli:	Thanks Scott. You too. You guys have always been great to work with as well.
Scott:	Thanks man. Maybe at any parting thoughts and then let the audience know how they can get a hold of you.
Eli:	As far as parting thoughts, on the tenant side, as I mentioned already, I think you want to just really assess what your needs are, start looking internally about how many people are going to be working full time in the office. How many people are going to have flexibility, how many people are going to be remote full time. And I think from that perspective, that’s an important thing for companies to start doing. As you gather that information over the next few weeks or months, the market’s going to be a lot more favorable for you, whether that’s better rents, more flexibility on term, just having more options to pick from, finding space that’s already furnished, any of those things. That’s how I would approach it. In terms of how to get in touch with me, first name is E-L-I. Last name is C-E R-Y-A-K. Email is eli.ceryak@cushwake.com. I’m on Twitter as a CeryakEli, those are the best ways to get in touch with me.
Scott:	All right. You’ve been a pleasure, great job, great insights. And I always enjoy our annual real estate. And I know it’s going to be fun, we’ll look back if you few more years from now and be like, we can watch people track the real estate market by our conversations on the podcast. That’s pretty cool.
Eli:	Agreed.
Scott:	All right buddy. Thanks so much for coming by.
Eli:	All right. Thanks Scott.
Singer:	(singing) It’s Kruze Consulting Founders and Friends with your host Scotty Orn.

How Startups should manage commercial real estate during Covid

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