Property Management Services in Boston - Winter 2014/2015

I N N OVAT I O N WATC HWinter 2014 / 2015

One International Place, Boston, MA 02110 @CassidyTurleyMA

When it comes to innovation, ‘market disruption’ is the name of the game. Innovation, in its pur-

est form, is the crusade to create something that makes people stop using what came before. The automobile dis-rupted the horse and carriage industry. iTunes turned the music industry upside down. And the smartphone, with all of its apps, is disrupting everything from shopping to journalism to real estate brokerage.

Yet only in its modern definition has the word innova-tion become synonymous with progress. Historically, the term carried a strong negative connotation – oddity without purpose. For centuries, those who dared innovate could be charged as traitors or heretics.

In fact, by most accounts it wasn’t until 1939 when Aus-trian economist Joseph Schumpeter used the term within the context of bringing a product to market that it received a more positive response. (Even then, its use was essen-tially limited to economic and academic circles.) Three years later, in Capitalism, Socialism and Democracy, Schumpeter would also go on to coin the term ‘creative destruction’ – the idea that “industrial mutation . . . rev-olutionizes the economic structure from within.”2 Stated succinctly - competition leads to innovation.

In his 1997 book, The Innovator’s Dilemma, Harvard business professor Clayton Christensen argued that com-panies doing the right thing are doing the wrong thing. Doing the right thing, as Christensen saw it, had brought decades of success. But it also meant missing opportuni-ties to innovate.

INNOVATION: A BRIEF HISTORY LESSON

The poster child for this ‘evolve or become extinct’ school of thought is Ken Olsen’s Digital Equipment Corporation (Digital). Spun off from MIT’s Lincoln Labs in 1957, and founded at Clock Tower Place in Maynard (where it occupied 8,600 SF at $0.25 PSF),3 Digital would go on to become the largest employer in Massachusetts by the 1980s. Its minicomputers were so revolutionary that ven-ture capital firm American Research and Development’s $70,000, 70% stake in the company was worth $400M by 1972.4 But when the personal computer came along in the late 1980s, Digital’s product had become dated. In 1998, its last remaining units were purchased by Compaq.

: the act or process of introducing new ideas, devices, or methods. Companies within this category fulfill one or more of the following: a: High percentage of engineers, technicians or R&D employees b: Creation of high-tech products (as specified on the US Census list of Advanced Technology Product Codes) c: Use of high-tech production methods 1

LANDMARKS IN GREATER BOSTON’S INNOVATION HISTORY: A TIMELINE

For purposes of this discussion we respectfully defer to BLS economist Daniel Hecker’s definition of high-tech and innovation companies with one exception-we have excluded the life sciences sector.

In-no-va-tion noun \i-nə-vā-shən\

LANDMARKS IN GREATER BOSTON’S INNOVATION HISTORY: A TIMELINE

1861 MIT is founded.

1877 Closely associated with Harvard, Edison’s Bell Telephone opens.

1886 First MIT spin-off, Arthur D. Little opens doors.

1895 King Gillette partners with MIT chemist William Emery Nickerson to develop the disposable razor.

1922 Raytheon is founded at 292 Main Street in Kendall Square. Originally called American Appliance Company, it will go on to perfect microwaves, radar and become one of the country’s largest defense contractors. 1937 Edward Land’s Polaroid opens - a spin-off of Bell Telephone.

1939-1945 WWII sends over $100 million to MIT for tech-nological and applied research funding. The result will be the perfection of radar and creation of anti-aircraft guns.

1946 Harvard spins off venture capital firm American Research and Development Corporation.

1948 Gerald Blakeley Jr. of real estate firm Cabot, Cabot & Forbes pioneers the concept of the planned industrial park along Route 128.

1951 First section of Route 128 opens.

1951 Not wanting to conduct military research on cam-pus, MIT creates spin off Lincoln Labs.

1947-1991 The Cold War brings more government fund-ing to MIT in the way of nuclear research.

1953 Researchers at MIT create “Whirlwind,” the world’s first minicomputer. The team includes Ken Olsen who will go on to found Digital Equipment Coorporation.

1957 By 1957, more than 200 companies have relocated to Route 128-including M/A-Com, Millipore, and Sylvania. Nearly all of them have moved from within 4 miles of Boston’s city center.5 1958 Department of Defense is founded.

1962 Purchases by the federal government (predomi-nantly Department of Defense contracts) account for half of the sales activity along Route 128.

1967-1972 End of the Vietnam War and the space race slows down military contracts to the area. A decline in defense contracts and the significant loss of manufac-turing jobs forces companies along Route 128 to switch their focus from military contracts to consumer markets. 1986 Fortune Magazine declares Ken Olsen, founder of Digital Equipment Corporation, America’s most success-ful entrepreneur.

1991 Raytheon’s Patriot Missile is used in the Persian Gulf War for its anti-aircraft capabilities.

1998 Digital Equipment Corporation is no more. The few remaining business units are sold to Compaq.

2002 Originally known as CSN Stores, Wayfair is found-ed in Boston’s South End.

2004 Mark Zuckerberg and partners create Facebook in a Harvard dorm room.

2010 Adam Neumann launches shared space model WeWork. Now located in cities around the world, it occupies 140,000 SF at 745 Atlantic Avenue (Leather District) and 50,000 at 51 Melcher Street (Seaport).

WHERE DO ENTREPRENEURS COME FROM?

Long before there was Digital Equipment Corporation, there were companies like Bell Telephone (1877) and

Raytheon (1922). Innovative users have been part of greater Boston’s tapestry (and significant users of real estate) for over 150 years. Our exposure to academia, government funding, industry, and international communities led to a ‘big bang’– creating Boston’s pool of entrepreneurial talent.6 This combi-nation is so powerful that in 2012, Massachusetts was second only to California in technology patents per capita.7

When we talk about the origin of innovation companies, we generally start in Cambridge – specifically with Harvard’s Ivy League cachet and MIT’s technological talent. And our ten-dency is to focus on Kendall Square. While current tenants include industry giants Microsoft, Amazon and Google (and a slew of key life science players), the ebb and flow of the neighborhood’s tenant base has vacillated between start-ups and grown-ups for decades.

Pick up any of our market reports over the past 4 years, and the story in Cambridge will be the same – its astronomical rents preclude most tenants except the established and excep-tionally well-funded from securing even a small block of of-fice space. In fact, the average lease in the past 24 months is nearly 40,000 square feet (SF). But innovation’s impact on commercial real estate goes well beyond Broadway and Main Street. Decades before Kendall Square’s razor thin vacancy and prohibitive rents pushed start-ups to the Seaport and the suburbs, MIT spin-offs began to cluster along Route 128.

With World War II came advent of government-funded de-fense research in Massachusetts. The digital computer, de-fense guidance systems and microwave technology all came about as a result of the relationship between academia (name-ly MIT) and government.

When the war ended, MIT researchers (who had become ac-customed to generous funding and cutting edge technology) found it all but impossible to return to the classroom. So many of them turned to commerce – creating companies to bring these new technologies to market. The problem was that between 1935 and 1950, Boston and Cambridge had seen little new construction. And the buildings that had availabili-ties had become worn and dated. Where were these new com-panies supposed to go?

When Route 128 opened in 1951, the timing was perfect. Though its initial purpose was to divert traffic around (rather than through) Boston, it served a secondary function - pro-viding access to acres of undeveloped land just miles from Boston and Cambridge. Seizing on the pervasive desire for new, relatively inexpensive space with easy access to down-town, Gerald W. Blakeley, Jr. of real estate firm Cabot, Cabot and Forbes pioneered a concept that we now take for granted: the planned industrial park. As a result of his vision, 53 com-panies had moved to Route 128 by 1955. 24 months later, the number had increased nearly five-fold to 223. And by 1967, 728 companies called Route 128 home.8

But that was more than half a century ago. The latest wave of entrepreneurs has shown a preference for walkable urban environments. Three years ago, this led to a surge of migra-tory leasing activity in Boston’s Seaport District. It also led to an evolution of where start-ups are born and where they grow – with many ventures opting for social, rather than sol-itary spaces. This, in turn, has led to the emergence of shared space models. Perhaps Boston’s most prominent example is WeWork (founded in New York in 2010). Offering a downtown ad-dress and monthly memberships for individuals and compa-nies alike, the firm has come to occupy all but 1 ½ floors of the Leather District’s 745 Atlantic Avenue as well as nearly 50,000 SF at 51 Melcher Street in the Seaport District (just in the past year). We’re told that the only reason WeWork is not at 100% occupancy is because it continues to expand.

“. . .WHILE SOME MAY SEE THEM AS THE CRAZY ONES, WE SEE GENIUS, BECAUSE THE ONES WHO ARE CRAZY ENOUGH TO THINK THAT THEY CAN CHANGE THE WORLD, ARE THE ONES WHO DO.”

-STEVE JOBS, ON INNOVATORS

Graph Each year Inc. Magazine comes out with its annual list of the top 5,000 up-and-coming ‘growth companies.’ While there are many benchmarks to make the list, the most difficult requirement to meet is revenue-it must have tripled each of the last three years. The below graph illustrates the approximate percentage of growth companies within a given mileage of downtown Boston for the years 2009 and 2014. Over the past five years, this category has moved towards Boston’s center.

And the preference for urban amenities is beginning to spread to the suburbs too. Shunning the congestion of the city and lured by free parking, more established innovation companies are opting for mixed-use build-to-suits. Between CityPoint and the redevelopment of the Polaroid site at 1265 Main Street, the Waltham of today is a far cry from the Waltham of the 1950s.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

05101520253035404550

Perc

enta

gew

ithin

Corr

espo

ndin

gM

ileag

e

Distance

from

Financial

District

(miles)

2009

2014

Source: Inc. 5000 Magazine and Cassidy Turley Boston Research

The Seaport’s renaissance over the past 18 months points to the tendency of high-tech and start-up enterprises to

cluster together. The propensity to seek out similar neigh-bors is one that we’ve seen repeatedly throughout the region. For example, data storage firms in 128 Central (Oracle, Ac-tifio); robotics firms in 128 North (CyPhy Works, Kiva Sys-tems); and online video firms in the Financial/Leather District (Brightcove, Visible Measures).

In observing the rapid ascent of the Seaport, it’s obvious that its real estate fundamentals were driven in large part by eco-nomics – supply and demand. In 2011, the Seaport offered an abundance of space at a reasonable price. BrightCove and Communispace were the trendsetters when they relocated from Cambridge and Watertown, respectively.

IMPORTANCE OF CLUSTERING

FINANCIAL

DISTRICT

BACK

BAY

DO

WN

TOW

N

CROSSIN

G

GOV’T CENTER

/NORTH STATIONLEATHER DISTRICT

/NORTH STATION

MID

TOW

N

FENW

AY

SEAPORT NUMBER OF INNOVATIONLEASES IN

THE PAST 18 MONTHS

INNOVATION BY SUBMARKET

FINANCIALDISTRICT

DOWNTOWNCROSSING

32

SEAPORT 18

MIDTOWN 4

FENWAY 2

BACK BAY 14

10GOVT CENTER/NORTH STATION 8LEATHERDISTRICT 6

Figure While the Seaport has been dubbed the Innovation District, the Financial District has actually led the city in the number of tech deals executed in the past 18 months. With lower rents than the Seaport and East Cambridge, the Financial District is attracting companies looking for flexible, economical deals. (1 arc=1 deal)

Source: Cassidy Turley Boston Research

Clus-ter verb \lkləs-tər\: the act of multiple companies congregating in a similar area in order to:

a: feed off each other’s ideasb: attract/compete for employees

c: be housed close to funding partners

But now that even converted warehouse buildings are commanding rents in the low $40s, many firms have set out to colonize Boston’s more affordable neighborhoods – Leather District, Financial District, North Station and Downtown Crossing. Located in what is arguably Bos-ton’s next innovation frontier, Carbonite leased 52,000 SF and Sonos took 170,000 SF at 500 Washington Street in Downtown Crossing during the third quarter. This took the average innovation deal in that neighborhood from 4,300 SF to just under 12,000 SF in three short months – and an average effective rent from the high $20s to the low $40s.

Because venture capital firms (at least in New England) tend to invest in companies within geographical proxim-ity, it shouldn’t be surprising that they, too, have begun to migrate into downtown Boston. In 2013, both Battery Ventures and Polaris Partners inked deals for space at One Marina Park Drive.

And venture capital’s impact on the region extends fur-ther than direct investments. According to a 2011 report in the Review of Economic and Statistics, “a doubling in

Boston$58,450,000

10 MILK STREET

$57,900,20027 WORMWOOD STREET

$69,024,99821 DRYDOCK AVENUE

$31,869,100268 SUMMER STREET$55,503,000

33 ARCH STREET

$46,963,00031 ST JAMES AVE

$38,499,801699 BOYLSTON STREET

$51,468,900 177 HUNTINGTON AVE

WHERE THE TECH VENTURE CAPITAL IN BOSTON FLOWS

2012-2014$48,532,200800 BOYLSTON STREET

$48,970,000855 BOYLSTON STREET

$157,000,0004 COPLEY PLACE

Figure Exclusive of life sciences, the city’s largest ven-ture capital deal was with Wayfair at 4 Copley Place ($157M). Meanwhile, there were two buildings each with six significant VC deals - 31 St. James Avenue and 21 Drydock Avenue.

the supply of venture capital results in a 1% expansion in the number of jobs and a 1.4% to 6.4% increase in aggregate income.”9 The report goes on to suggest that the presence of small firms and entrepreneurship as viable employment options also creates upward wage pressure on existing employers.10 Which makes the presence of VC firms good news for everyone, not just entrepreneurs.

The importance of this flocking mechanism cannot be understated. It is imperative for the circulation of ideas – which has become the mission statement of urban incu-bators such as the rapidly expanding WeWork, WorkBar and Cambridge Innovation Center. As we have seen in the past 18 months, high-tech hubs attract high tech start-ups. If all goes well, high-tech start-ups become established signature tenants. And established signature tenants at-tract retail, restaurants and residential interest.

Source: PriceWaterhouseCoopers MoneyTree and Cassidy Turley Boston Research

Largely due to a multitude of post-secondary entrepre-neurship programs, the area around greater Boston is

saturated with entrepreneurs who flourish in the initial stag-es but who are less talented at taking their companies to the $1 billion mark.

And growth in the high-tech start-up sector is a complete-ly different breed of growth. As a recent McKinsey and Company article articulately pointed out, “if a healthcare company grew at 20% annually, its managers and investors would be happy. If a software company grows at that rate, it has a 92% chance of ceasing to exist within a few years.”11

According to the Bureau of Labor Statistics, about half of all new firms fail in the first five years. But this means that half do not. So what happens to these start-ups after they’ve moved out of an accelerator and are on their own? Hopeful-ly, they grow. And grow quickly.

Perhaps one of Boston’s most timely examples is e-retail-er, Wayfair, LLC. Just a few years ago, Wayfair occupied about 32,000 square feet at 177 Huntington Avenue. After undergoing a massive expansion phase, the company more than tripled its footprint when it leased 106,000 square feet at 100 Huntington Avenue in May of 2013 (the company physically relocated in July 2014). In the first quarter of 2014, Wayfair received $157 million in financing (ahead of its October IPO) – valuing the company at more than $2 billion. As a result of further anticipated growth, Wayfair took another 170,000 square feet at Copley Place in the first quarter – bringing its total footprint to 275,000 square feet – a nearly five-fold increase in less than five years.

Other local real estate growth stories include the recently public Hubspot. Born at the Cambridge Innovation Cen-ter in 2006, Hubspot renewed and expanded at 25 First Street in August 2013 – to occupy a total of 100,000 SF. Its October IPO brought the company’s market cap to just under $900M. Digital advertising firm Nanigan’s (which occupied just 6,000 SF on Tremont Street in 2011) grew into 21,000 SF on the 12th floor of 60 State Street. Their 18-month lease doesn’t start until December 2014 and they’ve already expanded to occupy the entire 12th floor.

SUSTAINING GROWTH ‘UP OR OUT’

$17.50 $18.30

$55.00$48.75$31.25 $24.75

$30.95$32.50

$33.00

$35.75$38.00

$38.25

$24.00

$43.70$30.50$35.65

$29.90$31.50

$24.50

$31.25$33.00

$32.65

$47.50$52.65

What Does An Average I nnovat ion Deal Look L ike?

E�ective Rent

Size

Base RentTI Package

Free Rent

Term

Building Class

Floor

East Cambridge

36,400 SF

4 MONTHS

7.5 YEARS

8 - 9

A - / B +

23,596 SF

2 - 4

6 YEARS

3 MONTHS

128Central

A - / B +

12,345 SF

7

4 YEARS

1 MONTH

Financial District

A - / B +

18,355 SF

Seaport

3

6 YEARS

3.5 MONTHS

B

7,100 SF

3

3.5 YEARS

1.75 MONTHS

Gov’t Center/North Station

B

4,500 SF

2

3.5 YEARS

1.25 MONTHS

LeatherDistrict

B -

11,300 SF

7

4 YEARS

2 MONTHS

DowntownCrossing

B -

Back Bay

18,200 SF

5

6 YEARS

2 MONTHS

A

WHAT DOES AN AVERAGE INNOVATION REAL EASTATE DEAL LOOK LIKE?

Source: Cassidy Turley Boston Research - ‘Effective Rent’ represents the average amount paid per SF per year over the term of the deal.

RT 1

28 4

3%

RT 495 19%

Boston 21%

Cambridge 7%Inner Suburbs 10%

50.5

%

28.6%11%

3.3%

6.6%

2014

2009

TOP INNOVATION GROWTH LOCATIONS

$17.50 $18.30

$55.00$48.75$31.25 $24.75

$30.95$32.50

$33.00

$35.75$38.00

$38.25

$24.00

$43.70$30.50$35.65

$29.90$31.50

$24.50

$31.25$33.00

$32.65

$47.50$52.65

What Does An Average I nnovat ion Deal Look L ike?

E�ective Rent

Size

Base RentTI Package

Free Rent

Term

Building Class

Floor

East Cambridge

36,400 SF

4 MONTHS

7.5 YEARS

8 - 9

A - / B +

23,596 SF

2 - 4

6 YEARS

3 MONTHS

128Central

A - / B +

12,345 SF

7

4 YEARS

1 MONTH

Financial District

A - / B +

18,355 SF

Seaport

3

6 YEARS

3.5 MONTHS

B

7,100 SF

3

3.5 YEARS

1.75 MONTHS

Gov’t Center/North Station

B

4,500 SF

2

3.5 YEARS

1.25 MONTHS

LeatherDistrict

B -

11,300 SF

7

4 YEARS

2 MONTHS

DowntownCrossing

B -

Back Bay

18,200 SF

5

6 YEARS

2 MONTHS

A

WHAT DOES AN AVERAGE INNOVATION REAL EASTATE DEAL LOOK LIKE?

Figure Each year Inc. Magazine comes out with its annual list of the top 5,000 up-and-coming ‘growth companies.’ This year, 145 of them are located in Massachusetts. While the clustering mechanism in downtown Boston is still somewhat new (the number of growth companies is up 10 percentage points in five years), it is important to note that Route 128 still has a devout following.

At the other end of the spectrum, consider ITA Software – a travel software company launched at MIT in the 1990s. Throughout the first part of the decade, the company grew – systematically expand-ing its footprint – first at Kendall Square and eventually into more than 30,000 square feet at 141 Portland Street in Cambridge. In April 2011, the company was purchased by Google for $700 million. Now housed in Google’s space at 5 Cambridge Center, its physical footprint has been absorbed into Google’s.

Locally, the focus on innovation companies usually comes from a financial perspective –VC funding, M&A activity, pending and executed IPOs and so on. But when it comes to real estate, the innovation sector presents a compelling case study.

With the days of corporate campuses behind us, the last few years have made it abundantly clear that walkable urban amenities (even in the suburbs) are non-negotiable. And neither are like-minded neigh-bors. Next on the list are economical rents, flexible lease terms and space conducive to collaboration. But whether we’re discussing an established firm expanding in Cambridge or a five-person start-up graduating from incuba-tor space, there is one universal requirement that supersedes all others: it’s taboo to move in where a prior tenant has died.

Source: Inc. 5000 Magazine and Cassidy Turley Boston Research

Endnotes

1 Hecker, Daniel E. “High-technology employment: a NAICS-based update.” U.S. Dept. of Labor and U.S. Bureau of Labor Statistics. July 2005; 128(7):58.

2 Schumpeter, Joseph A. Capitalism, Socialism, and Democracy. New York: Harper & Brothers, 1942. Print. 83. 3 Rosegrant, Susan and David Lampe. Route 128: Lessons from Boston’s High-Tech Community. New York: Basic Books, 1992. Print. 5.

4 Rosegrant and Lampe. 136.

5Rosegrant and Lampe. 108. 6 Rosegrant and Lampe. 13-20. 7 Massachusetts Technology Collaborative. The Massachusetts Innovation Economy Annual Index. Boston: The Innovation Institute at the MassTech Collaborative. 2014. 32. 8 McNichol, Dan. The Roads that Build America: The Incredible Story of the U.S Interstate System. New York: Sterling Publishing Company, 2006. Print 148-149. 9 Samila, Sampsa and Olav Sorenson. “Venture Capital, Entrepreneurship, and Economic Growth.” Review of Economics and Statistics. February 2011; 93(1):338-49. Web. 01 Oct. 2014. 10 Samila. 12-13. 11 Kutcher, Eric, Olivia Nottebohm, and Kara Sprague. “Grow Fast or Die Slow.” McKinsey & Company. April 2014. Web. 03 Nov. 2014.

INNOVATION WATCHWINTER 2014/2015

One International Place 10th Floor Boston, MA 02110

Ashley E. LaneVice President, Research Cassidy Turley One International Place Boston, Massachusetts 02110 Direct Tel: +1 (617) 279 4570 [email protected]

Matthew B. SmithResearch Analyst Cassidy Turley One International Place Boston, Massachusetts 02110 Direct Tel: +1 (617) 279 4589 [email protected]