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Comment by fredkbloggs | Hacker News Reader

This is a great analysis and the argument makes perfect sense in every respect. The only thing I find dubious is the idea that the bust is 2-4 years out. I think if you polled most SF commercial landlords, they would tell you that they expect most of their startup tenants to start having difficulty paying the rent in no more than 18 months. It would be interesting to see some actual data on this. After all, there's not much benefit to demanding 5-year leases if you think that (a) prices are going to keep going up for 3 or 4 more years, and (b) your tenants are mostly going to be solvent for at least that long. If the landlords really believed the bust were 3 or 4 years out, given the sub-sub-sublease problem, they'd take startups on 1-year terms at a MUCH higher rate than established tenants who could negotiate modest discounts on longer-term leases. The evidence presented suggests rather strongly that most landlords don't expect these startups to be in business in 2 years, and I agree.

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It's not that the bust is coming soon. Startups are notoriously bad tenants as a class, whose life cycle is too short. Signing long lease with them just doesn't make sense. By definition a startup is an experiment to build products and a business in a short amount of time, with one to two years of funding in most cases. 9 out of 10 these experiments fail, so 9 out 10 startup tenants will move out after a short time. Commercial landlords want long term tenants, not people going out of business in one or two years.

Commercial lease is really only applied to companies that can stay in business. A long lease is often not enforceable. The incorporated company simply declares bankruptcy and it's hard to collect the money on the full term of the lease. I remember in the Dot Com bust days some failing startups simply stopped paying rents but stayed on, to stretch that last dollar or to burn out that security deposit.

Even if it doesn't fail and turns into a unicorn, its space needs will rapidly increase and it will still want to move on to bigger and better offices.

The entire point of a startup is to not stay its current size - either it will grow wildly or disappear altogether.

If you can comfortably occupy the same amount of space for 2+ years, you're not a startup, you're a small business.

Exactly. Either way they don't stay long. Landlords have learned the hard lesson over the years.

I picture Ron Conways game of life as a view of office space use in SF :)

Did you mean John Conway or were you making a joke?

>The entire point of a startup is to not stay its current size

Growth for the sake of growth?

I would actually think that this is pretty far away from what startups are about.

"A startup is a company designed to grow fast. Being newly founded does not in itself make a company a startup. Nor is it necessary for a startup to work on technology, or take venture funding, or have some sort of "exit." The only essential thing is growth. Everything else we associate with startups follows from growth." - pg

Well, that's his view on it. I and many others would disagree fundamentally on those points.

There are many other types of business besides startups, and not all technology businesses are startups. That's fine, many of them work very well. Rapid growth is not the only way to run a successful business. But they're not "startups," by definition, they're some other kind of business.

You can, of course, attempt to appropriate the word "startup," redefine it to mean something else, and then attempt to get others to use your new definition, but empirically it seems that almost everyone is using pg's definition above for that word.

I guess everyone is entitled to interpret words however they like, but the salient attribute of a startup is exactly what the word means: it's a new venture. And from the perspective of a landlord, that's what matters. New companies are the least predictable in their needs, their revenue stream, and their long-term prospects. They tend to have inexperienced managers and flighty owners. All of these things are true regardless of how they are funded, what industry they operate in or whether the owners are trying to become huge overnight, bootstrap into a comfortable living, or whatever else.

Established companies grow and shrink, too. They close offices and factories, open new ones, and occasionally file for bankruptcy protection. But they do these things much less frequently than a new company, and they do it with the backing of a much larger and more reliable cash flow. That cash flow means that even in bankruptcy, an established company's creditors usually end up with a significant recovery. From a landlord's perspective, these are the things that make established companies more attractive than startups. Thus, in this context at least, "startup" means nothing but "new company" and carries none of the other connotations that most people here assume when hearing the term.

Whatsapp? Instagram? Headcount != success.

Growth in users or revenue does not always cause growth of headcount, but they are definitely correlated, especially in organizations with sales teams.

Of course, but I was countering the OP's point that "If you can comfortably occupy the same amount of space for 2+ years, you're not a startup, you're a small business."

I agree with pg's definition of a startup as being about growth (in the eponymous essay). In users, not headcount, in revenue, not funding. Even if there are many cases where one drives the other, targeting headcount growth and fundraise amounts as success KPIs is an instance of the https://en.wikipedia.org/wiki/Cobra_effect.

Avoiding revenue does seem to be a good way to "grow" sans headcount growth, but that seems like a rare exception to the rule rather than a reason to believe that valuation growth doesn't generally correlate with employee count.

I was trying to make a subtler point with the counterexamples: that focusing on the wrong KPIs lead to unintended and occasionally negative consequences.

Quick example: imagine you are an IT consultant brought in to automate data manipulation processes in BigCorp (or more often MediumCorp since BigCorp has an internal team doing this already).

There's 150 people currently downloading data into Excel, running a few macros they know nothing about, and then reuploading the CSVs. You figure out what the data flow is, read up the API doc, and build some kind of process that does it in 5 minutes in bash on a medium instance on AWS, whilst fixing the errors the macros were making.

Will it be an easy sell? You were expressedly brought in to do this, but you'll find that the manager in charge of the 150 people - let's call him the CXO - is going to fight every inch of the way to stop you from launching your product. He'll point at the diff between his crappy but nevertheless, in production stuff and your script as cause for audit, creating a weeks/months long review process (because nobody can find the time, or wants to take the responsibility and the fight). He'll blame you for creating a "toxic" work environment. He'll bog you down in endless 2h long lunchtime meetings unrelated to the main point in an attempt to make you lose your professionalism in front of external stakeholders. He'll list missing new features then put them through the audit process.

Eventually, once a few months have been wasted, he'll point at your lack of progress as a sign of your incompetence, even though the working version was ready to be rolled out months ago. Nobody will question him because the company is profitable and it doesn't really matter how the process is done, just that it gets done. So, you leave the project, pocketing your pay - which they will pay on time so you don't make a fuss - and things continue as before for the CXO and his team, perhaps even gaining approval for a further 50 in headcount to develop the new features or to compensate for the expensive SQL and scripting training (MS stack, of course) that he's sending his entire team to in batches, whilst you'll have made a bad impression on that company's management and be burnt out of their network.

The CXO benefits outside the company as well, as he can now say he managed XYZ employees which is how people automatically gauge someone's success. This enables a succession of ever greater responsibility positions (or entry to Harvard Business School, who actually asks you "how many reports did you have"). "Well, if the previous place trusted him with 150 people..."

It's even worse in startup space because VCs and many founders understand that growth at all costs is what matters, so there are significant incentives to doing it today, even if badly, vs doing it tomorrow but well and in a way that doesn't pile technical debt. It's a winner takes all, so you just need to pour in enough millions and you'll reap the billions (in fact this is also the very structure of a VC's portfolio, investing in 10 different ways of doing the same thing in the hope one wins, even if it means the others all die).

So some founders may be doubly incentivized: making the company as large and cash flow burning as possible both to appear like the obvious winner, and to justify mammoth fund raises at a time of abundant capital seeking yield; and, if things go wrong, well, they managed hundreds of millions of VC dollars and hundreds or thousands of people in dozens of global offices and it sounds damn good for their next try.

And this is where both WhatsApp and Instagram did things differently: they focused on getting the user growth scalable without enormous headcount growth, whilst - at least in Whatsapp's case - having enough cash flow to hold on until the mega acquisition (and in Instagram's case, sustaining the company on the early rounds). Pointing at lack of revenue is not particularly useful - I would say even a red herring - when even SaaS companies go 5-10 years without showing profitability and with enormous fund raises for growth (just look at the analytics space for recent examples).

The hedge fund space - which is almost by definition results driven - has already caught on - Bridgewater type funds with a thousand employees are the exception rather than the rule and seeing AUM over a billion USD per head is more common than "unicorn" startups.

I wish you'd talk to the owners of a company I worked for. After 4 years in business, they continued to interview people for positions at a "startup", requiring candidates to agree to stay late or work on weekends to make the business succeed.

4 years in, no profit. After 5 years, they became "profitable before marketing costs", which was the largest business expense (in the millions).

Huh. I should dig and find out if they still call themselves a startup from 2009.

Agreed, many landlords seem to feel like the trouble is a mere few months away, although often any attempt at getting them to discuss how they arrived at that conclusion gets something like "I just know it."

So one wonders about the whole "wisdom of the crowds" or "herd" in this case, and whether or not they can sense something that isn't showing up in other indicators. I've been looking but other than the extensively covered late stage valuation madness I've not found good correlation for this feeling.

A lot of this may come from the belief that the economy is only being propped up by the easy money policies of the Fed, and that the Fed is going to start tightening rapidly in the fall. There's a sense that once the tightening starts, everyone will run for the exits at once, and we'll have another 2008 situation but worse.

Your response coupled with your username gave me a shiver, heh.

That said, why would the Fed tighten money in the fall when we're so close to an election year? I know they hold longer terms to hopefully avoid political swings, but, it just seems like bad timing.

Well, if the Fed doesn't tighten, they're at a pretty high risk of introducing serious inflation into the economy. The high commercial rents are a form of inflation; so are the wages of tech workers, and people being priced out of the Bay Area. So far, this is local to a few industries and metropolitan areas, but if the Fed doesn't act you could see it start showing up in nationwide statistics.

That said, I'm not entirely convinced Yellen will tighten. She has a reputation as a dove on monetary policy and seems weak to me, overly afraid of the effect her actions will have on the stock market. It wouldn't surprise me if we end up with another 1997 situation, where some temporary economic instability makes the Fed put off tightening or even introduce additional stimulus, and this ignites a speculative bubble that raises prices beyond all reason and then bursts.

(The username is ancient, I've had it on various sites since college, and while I'd love to be thought of as a prophet, my track record isn't that good.)

On a nationwide scale, the oil-price crash is adding some offsetting economic slowdown (since the U.S. is a huge oil producer) which I think significantly reduces inflation risk. The previously booming energy sector is stalling and moving towards a contraction: reducing investments, laying off employees, etc. SF rents are going up, but Houston rents are going down. The overall engineering employment market is also getting slightly less tight as petroleum engineering is no longer sucking up every ounce of spare talent.

Plus just in terms of the benchmarks they watch: The headline CPI is currently at a miniscule 0.1%, way below the 2.0% target. The personal-consumption-expenditures (PCE) rate is somewhat higher at 1.3%, but still below the target.

"Well, if the Fed doesn't tighten, they're at a pretty high risk of introducing serious inflation into the economy."

I doubt this will take place. If anything, I think we will see deflation?

These low interest rates have provided gambling money to the 1 percenter's. (I don't want argue--just the way I see it.)

There's a part of me that want to cash in on these low interest rates(part owner in a home in the Bay Area--that people really seem to want.), but my inner voice--wants the fed to raise rates?

Why--the poor/middle class have been left out of the recovery(unless you are in tech.). We get essentially 0 % on our meager cd savings accounts. We can't gamble in this bubbly/momentum/free money stock market?

In essence, what the poor/middle class got out of this recovery is no change in wages, higher rent, higher fees, and 0 percent on our savings. (I do appreciate the access to health insurance though. At least, they(hospitals) can't attach my interest in a home-- if I got sick, and managed to survive? Before Obama Care, I couldn't get health insurance, and always knew I was one judgement away from being homeless. (For those that hate ObamaCare, I would be happy with a 2 million, nationwide--homestead exemption, incorporated into our federal bankruptcy laws? All homes should be judgement proof.)

So Janet--raise the interest rates. The rich boys are just gambling, and laughing! They have so much money they don't know where to put it? The REIT's are buying up too many commercial/residential units; on your free money--I sometimes wonder whether its foreigners(who can buy a home in the U.S., as easily as picking up a phone), or REIT's whom own more?

See, only the banks, and their Best clients are given this free money. I am not seeing the trickle down? We got out of the risk of Depression? It's time to raise rates, and never bailout another bank again.

Couldn't agree more. There is no inflation nationally, and we are nowhere near full employment. The only reason to raise rates is to curb asset inflation among the 1%.

The problem is that the American middle class needed the bailout that went to the banks and raising interest rates will hurt an already down and out main st. Frankly, we should have just given a massive tax rebate to the middle class. Of course, it's politically infeasible, but they would have actually spent the money in the real economy rather than using it to drive up asset prices.

nor was Nostradamus'

I'd turn that on its head: keeping short rates as low as they are requires extraordinary economic weakness. The only bad time to raise rates away from zero is when a total collapse is ongoing. None of the recent economic data suggests that a collapse is ongoing; quite the opposite.

You're right that it's bad timing in that their rate increase is likely to come shortly before a bust, and therefore will be second-guessed to no end. But that's the case precisely because it's coming far too late. The solution was to normalize rates near 2% during 2013 and then raise them slowly from there as data improved, not to delay further. Normalizing policy sooner would have limited the overheating this article is all about and therefore limited the impacts of the coming bust, perhaps even to a sub-recession level. Further delay will make things much worse.

The election is irrelevant to an independent central bank, and in any case the major elections are (not that you'd know it from reading the MSM) 15 months away.

The best time to raise rates was a long time ago. The next-best time to raise rates is now.

They would need a new approach to monetary policy to really have justified raising rates in 2013, because there was neither inflation nor full employment, the two things the traditional Taylor rule watches. Inflation was stuck around 0.1-0.2% for all of 2013 (below target), while unemployment was around 7-8% (above target).

If the SF Bay Area had its own monetary policy, things look a lot different in the local statistics, of course.

Part of the problem is that the CPI-U (and the PCE chain deflator) indicators they use don't do a very good job of capturing the cost of living for anyone. Cue rant on hedonics, basket problems, etc.

In the 70s the big focus was on the wage-price spiral, so hourly wages and prices paid were important indicators. Today there is zero wage inflation going on despite near-full employment, and instead asset prices are in an upward spiral. The preferred indicators should have changed to reflect reality but they haven't. That reality is that outside of a bubble sector there may not be wage growth during the lifetime of anyone now living. When the unions ruled the roost and labor's share of revenue was sky-high, a focus on wages was appropriate. Today, unions are almost gone, wage growth is nonexistent, and virtually all money being created is flowing to owners of capital. I'm not interested in debating whether this is healthy, and neither should the FOMC; that's not its job. But under these conditions, asset prices should be the primary driver of monetary policy, not wages or employment and certainly not the near-useless CPI-U. That driver is screaming slow down!!! and has been for some time now.

More like when the rates rise, investors seeking interest won't have to take on as much risk to get it, so a large volume of investors will go up a class leaving the riskier endeavors with a more difficult time getting funds. This is probably a good thing, preventing bubbles from forming and popping.

I don't think there is anything, including yesterday's fed statement, to suggest rapid tightening. Smart money is currently on a .25 pt increase in either September or December, with September slightly more likely.

That's less because the numbers (measured inflation and unemployment) actually call for an increase and more to just remind markets that: rates won't stay at zero forever and non-zero rates aren't the end of the world.

Not to pile on too much, but the Fed has been amazingly slow to raise rates and only shows signs of doing the most timid increase. It's the cheap money that's fueling the mad rush, yes, but it's a blunt policy tool being used to help along parts of the country that are really still struggling.

Until Detroit and Stockton and Pittsburgh are doing well again, aggressive policy is going to continue to fuel massive growth in SF and the Bay Area.

Tightening is not coming fast nor aggressively.

What happens if those areas simply don't start doing well again? Large parts of America have been declining for generations (West Virginia, much of Ohio, etc)

Which is likely. Echoes of the eurozone here for sure; SF probably needs 8% interest rates but even 0% is doing very little for the Rust Belt and other perennially depressed regions. Now, the eurozone critics think the problem is lack of fiscal union, but the US suggests it goes a lot deeper than that.

It's almost as if SF should have its own currency...

In principle, couldn't the issue be too few fiscal transfers? I.e. San Francisco should be paying even more into the federal coffers, to be redistributed even more to Alabama and New Mexico?

Or, thinking about the other direction, even restricting ourselves to within California San Francisco and the Bay Area single-handedly pay for a massively disproportionate part of state government services and redistribution. Perhaps it's time to go way back to metropolitan city-states as the proper scale of government.

See Tim Draper's proposal for splitting California into 6 separate states: https://en.wikipedia.org/wiki/Six_Californias

It doesn't make sense to separate Marin from San Francisco. And while we're at it, I'll take Sonoma and Napa. Maybe Davis too, because, you know, YOLO.

I don't think more fiscal transfers are the answer. If you took an even bigger chunk of money away from SF, you might succeed in reducing the rate at which real estate prices there are driven upward. But air-dropping that money in Akron will probably serve only to drive up real estate prices in Akron, which doesn't really solve anything (in particular, it does not increase output).

The problem here is twofold: first, not enough of the money being created is flowing into operating assets; second, the operating assets being purchased with this money aren't productive. This seems like an obvious and natural consequence of a service economy, in which the dominant inputs are labor and real estate. When you pay higher wages, that money has to go somewhere. Some of it goes toward consumption, but most is surplus and gets invested. It has the same problem it had when it was created: it can go toward real estate, operating assets, or portfolio investment. No one wants operating assets in a service economy (because they're not productive), so it ends up in real estate or portfolio investments. That drives up asset prices but does not increase output. Diverting more of this money into operating assets (things that make stuff) would increase output and alleviate the pressure on asset prices. Instead it goes into more wages (paying people more does not make them produce more) and real estate (paying more for land or office space does not make it produce more, either). One of the few bright spots was oil, but the sharp drop in prices has made investment there unattractive as well, and has reduced nominal output at the same time.

The central bankers can control the rate of asset price inflation by making money cheaper or more expensive, but they can't do anything to increase output when the money they create is used primarily to acquire nonproductive assets, or to acquire at higher prices assets that are already being fully utilized. That's why real estate is expensive and output is stagnant, and why fiscal transfers won't solve anything.

Any number of solutions suggest themselves: relaxing regulatory requirements to make manufacturing, utilities, and other non-service industries more productive; fixing China so that surplus cash in the US can be invested in operating assets there instead of domestic real estate; fixing laws that limit the supply of real estate, both to directly reduce the price and to make it less appealing as an investment; investing more tax revenue in infrastructure instead of transfer payments to individuals (where much of it ends up in ... real estate); radical alternatives like breaking up the United States into separate nation-states that are more cohesive internally. I'm sure you can think of others as well.

Federal Reserve's objectives operate at federal level, and involve national unemployment level (target rate of ~5%) and inflation (target rate of ~2%) http://www.federalreserve.gov/faqs/money_12848.htm

Pittsburgh's actually been doing very well over the last 10 years— the recession barely happened there. And, of course, the stakes are much lower when you can buy a nice house in the city or a nice school district for $150,000.

Detroit and Stockton, less so.

The strong real-estate market in general makes it a bit easier to act on these kinds of hunches, even if they're somewhat flaky. It's probably the case that a portfolio of big companies and clients in "conventional" industries poses less risk over the next 5 years than a portfolio of startup clients does, regardless of your exact estimates of the probability/timing of a potential crash in the startup market. With rental rates what they are, you can still make a ton of $$$ by renting to those other clients. So why not take the lower-risk clients, even if it leaves a few bucks on the table in rent? Once you're making really healthy margins, attention often turns towards thinking about how to maintain them and avoid big risks to those margins: you're a lot more worried about the possibility of everything going south next year, than about juicing the margins another 10-20%.

As James Surowiecki makes clear in his book "The Wisdom Of Crowds", the wisdom is only apparent in situations where the people are not able to talk to each other. But real estate agents are able to talk to each other.

In Surowiecki's telling, if you get a room full of people to write down a guess about how many jelly beans are in a jar, the average of all the guesses will be surprisingly accurate. But if the people are allowed to yell the answers aloud, the first person who yells a guess "anchors" the guesses, and so if that first guess is radically wrong, a substantial bias is introduced into the overall distribution of guesses.

Real estate agents in a small geographic area, such as one city, often talk to each other, and therefore they generate a conventional wisdom, but each of their opinions influences everyone else's opinion. So you can get a herd action that is greatly at odds with reality.

Except in this case it's not just a local phenomenon. My company does business in several markets outside the valley (and outside CA) and we are hearing the same thing, often with the same lack of evidence but no direct connection between the sources. That said, I do think there's an industry echo chamber effect.

That's a delightful observation. Is the book worth reading?

Yes, it's very good for a pop-science book.

What happens if nobody yells their guesses and people only talk to one other person at a time? That's more like what happens with real estate agents.

Not quite, because there are trade publications, conventions, forums, linkedin groups, etc... You have the 1:1 but also the broadcast

Everyone I've been talking with seems to say "less than 24 months".

Have they been saying that longer than 24 months?

No. Same people were "no bubble" 6mo ago.

I've been solidly in the "actual value is being created by a lot of companies, mainly because tech (via startups) is destroying existing monopolies", but that's less true of some.

I think SF itself is probably a startup bubble and will correct, but it might just be a "go back to how things were a year ago", not a complete implosion. And the least bad way for this to happen is by sub-sector, like happened with all the shitty social buying apps a few years ago.

I did YC back in S11 and people were telling us "Winter is coming" even then. Markets are cyclical but it doesn't make so much sense to stress out about it.

It makes a great deal of sense to stress about it when you have a lot of long-term debt used to purchase your real estate assets, and have some control over the lease terms you offer. If you think the end of the boom part of the cycle is 6 months away, you want to lock people into the longest-term leases possible, so that they expire when the market is again, if not strong, at least not weak. If you think the end of the boom part of the cycle is 4 years away, you want to offer the shortest-term leases the tenant will accept, because they will then be forced to renew at a higher rate.

This is very similar to the dry-bulk market. It should be instructive to look at how companies like DryShips and Diana Shipping handled the enormous spike in the Baltic Dry Index several years ago, how they've fared since, and how they've managed their businesses afterward. The cyclical nature of markets cannot necessarily be controlled, but it can be harnessed to outperform one's peers, and if you are a REIT portfolio manager or smaller property manager, your job depends on doing just that.

And they've been saying it for at least 24 months.

Most startups fail pretty quickly. It seems reasonable to me.

I have talked to people who are in property management companies who are worried about (possible) rising interest rates are going to do to their profitability. It may not be a concern in SV but elsewhere very much so.

The REIT's that own Class A space are conservative. This reflects the investment goals of the institutional investors whose money they hold. Real-estate time horizons are long term in order to span across market cycles and because of the underlying nature of the asset. Real property really is different.

It doesn't really take a lot of intuition to know that the vast majority of startups are going to fizzle. Heck, "fail fast" is a mantra of the startup scene. Landlords just "know it" because they've already gone through it.

I think that the shared office spaces are really a wonderful solution so that young companies can have a great space without the long-term commitment. Ironically when we visited one (in Chicago) there were quite a few corporate "outposts" there with large companies like IBM.

According to the article, landlords expect economic cycles to last 7-10 years, and the last bust was in late 2008. So the next bust can be expected to occur somewhere between late 2015 and late 2018.

It's already close to late 2015, so the halfpoint of the predicted period is only 18-21 months away. That fits your observation that landlords expect the bust to be less than 18 months away.

I think that horizon was meant to be in general, not on a per-startup basis. If any given start up fails in 12 months (expected), the space can be sub-leased to someone else - but they expect this scenario to only be the case for another few years.

Yeah but if they're really remembering 2000, they know that's not so. There's always going to be some nonzero attrition rate among startups, but once a bust is under way the door slams shut on all of them at once. I'm saying I think (and think that landlords also think) that the door is going to slam shut in 12-18 months (maybe even less), not 36 or 48.

Based on the title, I expected this to be an article ranting about how someone thought their startup was being discriminated against.

Surprised that was, dare I say, "fair and balanced".

The company that produced the post needs to understand the actual reasoning behind the local market for their business to be successful so no room for ranting I'd imagine.

What interested me was the way that in this discussion, each of the separate reasons for the landlords being reluctant to rent to start-ups has been discussed separately - analysis - where what the landlords are doing is making a synthesis.

A relative of mine made the mistake of renting to a start up. Rent has not been paid for several months. Legal proceedings have started. ( This is in a country where evicting tenants is notoriously difficult. )

What country is that? Sure isn't the U.S.

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