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Are San Francisco tech companies disclosing real estate risks adequately? October 15, 2013

Posted by Bob Cook in Company Case Studies, Financial Planning & Analysis, Real Estate Markets, Silicon Valley.
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Twitter HQ - big enough?

Twitter HQ – big enough?

Tech companies in San Francisco ought to all know that one of the main growth constraints they face is the availability of office space to house workers.  Availability of the highly-sought-after so-called “creative space” is near zero.  Even if a company is willing to forego exposed timber, high ceilings, skylights and other cool features and settle for more conventional space, according to Colliers research, only 9.7% of the downtown San Francisco office space is vacant, and that percentage is declining fast.  The amount of space being sought by tenants currently in the market represents about half of the limited vacancies.  Undoubtedly, some companies are not going to be able to find the right space in the right location at the right price to meet their needs.

Boilerplate 10k disclosures

Yet, while San Francisco-based companies disclose in their 10K’s a seemingly endless list of risks, I don’t know of any who have cited availability of real estate as a risk to the growth of their business.  Almost all tack on a boilerplate nothing like the following at the end of Item #2 regarding Properties in their 10-K’s: “We believe that our facilities are adequate for our current needs.”  If any mention is made of future needs, it’s usually a statement like this one from a well known tech company headquartered in downtown San Francisco:  “If we require additional space, we believe that we will be able to obtain such space on acceptable, commercially reasonable terms”.

Really?   With downtown San Francisco vacancy possibly approaching 5%?

Maybe it’s time for disclosures about real estate to be taken more seriously.  After all, the value proposition to prospective shareholders of most tech companies is not based on their current level of profitability, but rather projections of much greater profitability in the future.  In our “new economy”, where office space to house knowledge workers needs to be considered a factor of production, the availability of this resource cannot be treated so cavalierly.

The issue of real estate as a constraint looms particularly large, one would think, for companies filing for IPO’s, but it’s unclear whether disclosures are taken much more seriously there.

Twitter’s IPO

Take the case of Twitter which has recently filed its IPO registration statement.  The statement reveals that Twitter currently has negative net income, so clearly the value proposition is all about growth.  The statement lists 28 pages of “Risk Factors” many focused on constraints to growth, but the only reference to real estate as a constraint is about data centers: “we cannot be assured that we will be able to expand our data center infrastructure to meet user demand in a timely manner, or on favorable economic terms”.  There’s no mention of real estate to house all the folks doing software coding, administering data systems, selling advertising, and generally managing the enterprise.

Now, Twitter, to its credit, may have its non-data-center real estate needs under control more than most companies.  In April of 2011 it made a bold, visionary move when it leased space in a giant building on Market Street in a prominent, easy-to-reach location, but one that is adjacent to a red light district.  After amendments, Twitter now has about 300,000 square feet under lease until November of 2021.  In moving to a less-established office location, Twitter was able to grab a lot of contiguous space at a price that, presumably, allowed it to bank space for the future.

Apparently, though, it wasn’t enough.  There are reports that Twitter is currently in negotiations for another 320,000 square feet.  What happens if its negotiations are not successful?  Will growth be limited?  I’m sure enquiring investors would like to know.  It would have been nice if the IPO registration statement had explicitly addressed the question of availability of real estate to grow.  As it is, we don’t know if the omission of listing real estate availability as a risk to growth is because Twitter actually has its needs covered for the foreseeable future or because it was simply following bad industry practice of not taking real estate availability seriously enough to disclose it as a risk if, indeed, unavailability might be a problem.

Is availability of real estate a material risk?

Some observers might say that availability of real estate is not material enough a risk to list in financial disclosures.  Any real estate executive, however, who has been ordered “don’t let real estate limit our growth” is keenly aware of how real this risk can be, particularly in San Francisco.  And while there are workarounds for San Francisco companies, like hiring people elsewhere or letting them work from home, companies are in San Francisco because that’s where they think the talent is or at least to where it can be recruited.  That’s where they think there’s a unique tech vibe that energizes their companies.  And that’s where they go to great lengths to make their workplaces cool so they can attract the best talent.  They wouldn’t be paying the premium to do business in San Francisco if having workplaces in the city were not so important. So … if they can’t find that space to create cool workplaces to house the workers they want to hire, isn’t that a material issue?   And shouldn’t the risk that they might not be able to get the space be disclosed to investors?

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