DivcoWest is returning to its roots and working on reshaping the industry.
THIS ARTICLE WAS PUBLISHED IN THE ‘Q’ – THE REGISTRY’S PRINT PUBLICATION – IN JANUARY 2014[dropcap]S[/dropcap]tuart Shiff founded DivcoWest Properties in 1993. Since then the real estate investment firm has acquired more than 30 million square feet of commercial space in North America. DivcoWest and its affiliates now manage more than $2.5 billion of equity from offices in San Francisco, San Diego and Boston.
Before starting DivcoWest, Shiff was responsible for development, construction and leasing at Divco Ltd., a family-owned Canadian development and construction company. He holds a bachelor’s degree in civil engineering from the University of California at Berkeley. Shiff serves on the board of the Real Estate Academic Initiative at Harvard University and the policy advisory board of the Fisher Center for Real Estate & Urban Economics at the University of California Berkeley Haas School of Business.
Q: 2013 was DivcoWest’s 20th anniversary in the real estate business. As you reflect on the cycles we’ve experienced in the Bay Area market over the past two decades, what was the best lesson you learned, and what do you think is the most important thing to keep in mind as we all look ahead to the next few years?
SS: First and foremost is to respect and appreciate the importance of perspective and relationships. We learned how important this is over two decades of active participation in the challenges, rewards and cyclical nature of real estate, particularly in Northern California.
One of the principles impressed upon our team is that we are not looking to reinvent the wheel, but rather replicate it…with nuance. The markets will always ebb and flow, but maximizing success (or minimizing failure), always lies in the ability to navigate those ebbs and flows—and find opportunities in any portion of the market cycle.
There is no question that the recovery in Northern California has been substantial. Local economies have improved while interest rates and cap rates have remained low. The nuance here is that Northern California is comprised of numerous sub-markets, each consisting of several micro-markets. Recognizing and understanding the unique characteristics of each [of] these markets is the key.
The improvement in the micro-markets has not been uniform. Many transitional assets remain that provide value-added opportunities, especially as tenants migrate to locations where the right balance of lifestyle, competitive advantage and economic feasibility converge. We know we must understand these migration patterns to correctly determine what to expect next from our tenants. Part of that is to value the insights provided by both the tenants and the brokerage community.
Q: You effectively started with a focus in the technology space. As DivcoWest grew, the opportunities across the country opened up, and you followed them. But, with recent Silicon Valley investments in the former Mission West Portfolio and recently the acquisitions from EOP of former Carr assets, you seem to be coming full circle as far as market emphasis.
SS: Northern California is where we learned many of the real estate lessons on which we base our investments today. But we also have a long history of being active in other key markets around the country, like Boston and Austin. Most, if not all, of our opportunities have focused on growth-oriented, supply constrained markets. These markets benefit from a strong foundation built on education and employment.
No doubt that Northern California epitomizes the characteristics that we are looking for, particularly when one has learned where to look. As the tenants in this market have grown and migrated into other markets, we have been fortunate enough to understand which locations they found attractive, and have grown with them.
Over time the technology industry has evolved from providing more “wanted” products to more “needed” products. It is now thoroughly intertwined in all industries and on many levels. This move from a vertical to a horizontal has created a more sophisticated scope of demand, one that involves both talent and innovation issues.
Like our clients, we are focused on improving the path from education to employment and leasing to price appreciation. While opportunities continue to occur nationally, Northern California has remained a primary source of “supply” since many of the innovation decision-makers continue to live and work here.
One of our most important roles in this new industry-level equation is to provide a reliable, educated and proactive resource that can enable technology industry leadership to provide for their expansion nationally. That requires knowledge that goes beyond just the needs of hardware and software. We are developing an expanded knowledge base for ourselves, for example by understanding the needs of life sciences researchers, and those looking at manufacturing products for emerging areas like robotics. We also need to better understand how to create attractive communities that can actively retain intellectual capital and spaces that can join multiple technology uses under one roof.
Q: Late last year you made a very big bet on Silicon Valley, especially in South San Jose. What fundamentally drew you to the South San Jose opportunity, and your recent North San Jose acquisitions?
SS: The Mission West transaction embodies several of the fundamental strategies that DivcoWest is continually trying to implement and improve. This was an opportunity to draw upon a number of our strengths, like buying low-basis transitional assets where we could utilize our expertise to reposition and stabilize. We felt we understood the market dynamics, which enabled us to better determine what might be next from a leasing and investment perspective. We’ve also put a lot of time and effort into building and maintaining the real estate relationships that positioned us to pursue and close on favorable opportunities.
As I mentioned earlier, one can have different perspectives on any given market depending upon the level of understanding. The example of Google Earth is often used at DivcoWest to show the complementary nature of different individuals within the company focusing on different aspects of our business—in order to develop the most comprehensive view of our world that we can.
The same idea can be applied to Northern California. An outsider would see Northern California or Silicon Valley as one market. But Silicon Valley is, in fact, comprised of several sub- and even micro-markets, each with its own dynamics.
As an example, we have generally observed a tenant migration from northwest to southeast in the San Jose / Silicon Valley corridor, concluding that, as markets like Palo Alto move below 10 percent vacancy rates, the migration moves southwest to Mountain View, etc. The path clearly leads to San Jose. When evaluating this portfolio, we felt we would be able to get ahead of the curve and pay what is a very attractive basis for the San Jose assets. It was an acquisition that made a lot of sense. In retrospect, I think we also recognized the advantages of controlling much of the vacancy in a sub-market that was otherwise quite strong.
Q: Some people are very bullish on San Francisco’s ability to attract and retain both tech companies and young technical talent. However, that focused environment has only existed over the last few years. For example, could the center of Bay Area economic gravity really shift to the city on a more permanent basis—or are we witnessing a temporary occurrence?
SS: Interesting that in some ways the very industries that are expanding are the same ones that simultaneously improve everyone’s ability to access information and generate productivity, many times remotely. That effect has never been greater. Increased mobility and accessibility can lead to more flexibility for talent to choose where they want to live, including the dense urban neighborhoods in San Francisco. Companies may find those same locational choices important, especially if they want to compete by more effectively attracting, accommodating and retaining top talent.
San Francisco has always been known for a diversity of amenities and a culture that appeals to all generations, in particular younger workers. Over the past 10 years, technology has both broadened and deepened this area’s talent pool, including some educated here and some abroad. This ability of cities like San Francisco to adapt, in this case by helping businesses find ways to establish their companies in preferred urban sub-markets, has kept this talent happily ensconced.
Technology is now intertwined throughout business and culture. Every company across the board now has to rely on innovation to grow, which goes back to the concept of tech as a horizontal not a vertical.
Additionally, the demographics of the technology industry have continued to expand with time. The tech leaders with whom I began relationships 20 years ago now have extended families. Some, as I can personally attest, are becoming empty nesters. This means that technology is covering much more of the life cycle and is requiring a more diverse set of lifestyle choices. The Bay Area seems naturally able to expand with tech because the region provides so much diversity. There is just a little something for everyone here and the continued strength in real estate reflects that.
As density increases, the challenge, of course, will be in our ability to maximize space uses by integrating different aspects of technology into intertwined communities throughout Northern California. There isn’t any cogent reasoning I am aware of why biotech should not coexist with business technology. Or, that light manufacturing of technology instruments acts at cross purposes with life science research. In fact, I believe that more synergies can evolve out of close proximity and shared intellectual capital, and that can lead to an even greater diversity of industry resources and businesses. After all, isn’t that how Silicon Valley flourished?
Again, because of its already existing diversity, I think San Francisco and the rest of Northern California “gets it” more than some of the other markets. Think regionally. We already have the intellectual capital to feed an even bigger global success. Besides, this market is a great place to be, especially if you are providing the environments these industries need to grow.
Q: What are the key things you will be looking for in making investment choices for your investment strategy during the next 12 to 18 months?
SS: The next 12 to 18 months will be about continuing to invest in the markets and assets that have demonstrated the ability to attract talent and build resources. DivcoWest’s investment initiatives will remain focused: buy at what we believe to be an attractive basis; manage maturities whether lease, debt or fund life; and be diligent in positioning each investment to be sold at a beneficial point in the market cycle.
Technology companies will continue to broaden their influence and will certainly require even more engineering talent to do so. As a result, universities with strong technology curriculums like Cambridge, UC Berkeley and Stanford will continue to provide well trained minds for expanding businesses. These businesses will, in turn, help to guide our investment decision-making within both our existing markets and for potential opportunities in newer markets.
Another focus will be to expand our requirements for acquisitions. Things like access to transportation, onsite parking, flexibility to accept infrastructure upgrades, proximity of compatible technological uses and support resources and building infrastructure aspects that often take a back seat to forward planning.
In general, the real estate markets have recovered substantially from the trough in 2009. However, the opportunities to find transitional assets in need of leasing or capital remain available throughout our targeted submarkets. Additionally, the demand for core product is very strong from both domestic and foreign buyers. As always, our particular challenge is to continue to find the right product, execute our business plan and have the necessary core buyer demand upon completion of that business plan.
Photography by Laura Kudritzki