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​​​Risky business in the most dynamic cities

San Jose is the second most dynamic city in the world. But that title doesn’t mean a stable future.

In 1970, desktop computers hadn't hit the market and hardly anyone envisioned that speed-of-light processors, real-time social media or wearable technologies would become part of daily life in the next 45 years. Back then San Jose, one of California's oldest cities, was home to fewer than 100,000 residents, and was surrounded by farming and rural areas.

Today the cattle and dirt roads have long since been replaced by code writers and Wi-Fi-enabled buses. The relentless expansion of the technology industry has not only made San Jose the fastest-growing city in America but, according to JLL's City Momentum Index, also the world's second most dynamic. While that rapid growth is enviable, it can also be a double-edged sword for new businesses looking to put down roots in the self-proclaimed "Capital of Silicon Valley."

San Jose at night

San Jose by the numbers

2

Most dynamic city in the world, according JLL’s CMI


5.2%

Unemployment rate; 2% below the national average
source: JLL Q4 2014


213,594

Hi-tech employees
source: JLL Q4 2014


33%

Annual output is generated by “innovation industries”
source: SVCIP, 2015


$1.4 billion

Total high-tech VC funding
source: JLL Q3 2014

By Dan Lorca (Dan Lorca) [GFDL, CC-BY-SA-3.0 or CC BY 2.5], via Wikimedia Commons

JLL's second annual City Momentum Index looked at 120 cities around the globe and found that the San Jose region, which includes Palo Alto, Mountain View, Sunnyvale and Cupertino, ranked just behind London as the "most dynamic city" in the world. Unlike other real estate reports, the CMI combines socio-economic factors, like innovation and education, with real estate dynamics, like construction and absorption, to track how quickly cities are changing.

San Jose has come a long way from its muddy roots. But the CMI shows that the factors that set San Jose apart from other innovation hubs also put the city at risk. San Jose's low 5.2 percent unemployment rate and high 3.9 percent year-over-year job growth are almost entirely due to the high-tech businesses that call the region home.

"The high-tech Millennial generation has been exhibiting a strong preference for areas with access to local public transit, walkable retail amenities and opportunities to transition to companies in their industry," says Christan Basconcillo, senior research analyst with JLL (and a Millennial himself). "While Silicon Valley is largely suburban in nature, dense micro-urban communities where people can work, live and play are becoming even tighter in Palo Alto and Mountain View."

Innovation industries, including high-tech, generated roughly 33 percent of Silicon Valley's output in 2013, and directly employed more than a quarter of the workforce in 2014, according to the Silicon Valley Competiveness and Innovation Project. Companies are constantly battling each other to hire the best engineers, programmers and coders. This talent war extends to hand-picking top candidates from the local universities—Stanford University, UC Berkeley and Santa Clara University, to name a few—to work at San Jose's idea-driven companies like Google, Ericsson and ServiceNow, which signed the largest office-relocation/expansion leases of 2014 to accommodate their growing workforces.

The San Jose area is about more than just tech companies, though. Silicon Valley is ahead of other "innovation hubs," like Austin, New York, Seattle, Boston and Southern California, in developing new businesses. JLL found that in addition to being a magnet for venture capital deals and investments, San Jose has the highest number of patents registered annually (nearly doubling between 2003 and 2013), earning it the top spot for international patent applications per capita. Palo Alto also boasts the highest concentration of AM 100 law firms in the Valley.

But growth at such a breakneck pace also creates risk.

Silicon Valley is extremely dependent on foreign workers. According to the SVCIP, more than half of the skilled workers in the STEM (science, technology, engineering and mathematics) industries are foreign-born. Only one out of five is a native Californian. Without visas to stay in the U.S. indefinitely, they risk being kicked out of the country.

Then there are the twin problems of racial and gender gaps in the employment mix in Silicon Valley. After withholding its workforce-diversity data for years, Google released it in May 2014, admitting that "the numbers are not where we want them to be." According to USA Today, black Americans make up 12 percent of the U.S. workforce and Hispanics 14 percent. Compare this with the tech giants whose home bases are the San Jose market: At Google, 3 percent of the staff are Hispanic and 2 percent are black. At Yahoo! and Facebook 4 percent are Hispanic and 2 percent black.

Then there is the shelf life of startup companies and VCs. While there are always new companies forming in Silicon Valley, "firm destruction" is also common. Silicon Valley companies expand, contract, open and close at higher rates than companies in other innovation regions, says SVCIP. In fact, 38 percent of businesses in innovation industries, like high-tech and STEM, hired or fired workers in 2013.

And then there's the high price of real estate. Rent per square foot for high-tech companies in Silicon Valley is a cool $40.44 as of the fourth quarter of 2014—nearly twice the price of space in Atlanta and Dallas—and will only continue to rise in downtown micro-markets and core submarkets due to frenzied demand and a relative lack of space. Housing prices are back to prerecession values too, which creates a huge barrier to entry for new high-tech recruits looking to relocate to the Valley. "Mountain View and Palo Alto downtowns are seeing frenzied, dot-com-like demand," says Basconcillo. "Palo Alto is 179.7 percent over market rent prices."

California's oldest city has come a long way in the last 50 years. How it handles its growing pains will go a long way toward dictating what it becomes in the next 50.