Square Feet

We’re starting to see more reports of the credit crunch infecting Silicon Valley make the mainstreem press. IHT came out with an article the other day discussing how startups in Silicon Valley are beginning to feel the crunch.

For the most part, landlords and brokers have remained fairly bullish on the prospects of Silicon Valley with some landlords continuing to raise rents on some buildings despite having signed no deals in the building at the lower rental rate they were asking only a few months ago. It should also be noted that some landlords such as Jay Paul at their Moffett Towers project have been lowering rents at the same time.

But I think many people are making a mistake here. They’re looking at what’s on the ground now and assuming that because we have so many multi-national companies here, we will somehow be okay. But Silicon Valley has never been about “today”. It has been about innovation, and “tomorrow”, and that’s where I think people need to look when assessing the situation.

What is happening with the capital markets is affecting startups today, but tomorrow it will be the VC’s themselves who face a tight capital market when looking to raise capital for their next fund. VC’s with solid track records will likely be able to raise additional funds, but many others will likely not be as fortunate. As a result, we’re seeing some VC’s becoming increasingly cautious with their existing capital, and funding fewer companies and under better terms. It is that reason why that unless the capital markets are able to sort themselves out, Silicon Valley will not be immune and the downturn may be worse than many think.

Quite a number of startups were advised to hold excess cash in instruments referred to as Auction Rate Securities. These assets, classified as AAA debt have recently been dragged into the lock-up of the credit markets.

In an effort to achieve enhanced returns on their cash, some startups are now finding themselves in a cash crunch. Some reports estimate that up to 20% of startups hold some of their funds in ARS, with some stories reporting holdings into the millions of dollars.

The lockup of the ARS market occurred in late February. In the event this evolves into as big of a problem as some are predicting it to be, we should here about more venture loans collaterized by the ARS taking place, in addition to hearing about some startups perhaps even going under.

The Fed’s recent actions to help stabilize economic conditions are not impressing foreigner’s holding US debt instruments. The inflationary actions of the Fed have resulted in foreign buyers of US debt to essentially boycott government auctions for treasuries.

Over the past eight weeks, the share of foreign buyers participating in these auctions was somewhere around 25%. In last week’s auction, they represented only 5.8%.

Additional steps the Fed has taken or will take this week include bailing out Bear Stearns by essentially financing a JPMorgan takeover of Bear Stearns. The emergency overnight rate for bank’s was cut by 25 basis points, and in the Fed’s next meeting, they might cut interest rates by as much as seventy five basis points.

Unfortunately though, the Fed can only control short term rates. What the Fed cannot do is control long term rates and that is what will affect commercial real estate going forward. The current economic conditions, compounded by inflationary pressures and increasing long term rates does not bode well for holders of such real estate. What we see is people continuing to be bullish in certain market sectors, but it is hard to see how they envision that some sectors, such as Silicon Valley, will escape unscathed.

Time will tell who is right, but with a weakening dollar and thereby increasing commodity prices (for those priced in US Dollars), the effect will be felt in Silicon Valley. We are seeing some Venture Capitalists increasingly wary of their ability to raise any more money in this market and have become increasingly conservative in placing investments.

This has already and will continue to have an impact on the Silicon Valley Market.