The tech sector ‘bubbles’ up

Bears fret that valuation gains foreshadow a pop

From left: Mark Zandi and Mark Cuban
From left: Mark Zandi and Mark Cuban

It’s the Pavlovian effect of the business world: whenever venture capital starts flowing into start-ups en masse, observers warn of a market crash. The current tech boom is no exception.

As former start-ups like Twitter or Facebook achieve sky-high valuations on the stock market, pessimists fret that a crash is inevitable. In March, telecom billionaire Mark Cuban became the latest skeptic. He wrote a blog post titled “Why this tech bubble is worse than the tech bubble of 2000,” arguing that venture firms are piling into start-ups that offer no prospects for a payout.

A tech bubble is of more concern to the real estate industry now than it’s ever been. For starters, tech firms have become important tenants in Manhattan’s office market. And unlike past cycles, the current boom has given birth to a large number of real estate tech start-ups. If a bubble pops, brokers, landlords and others in the industry stand to lose a lot of money.

Thankfully, the major factor in most bubble calculations — tech firms’ stock price-to-earnings ratio — looks reassuring for now. In March 2000, the average price-to-earnings ratio (PE) of firms listed on the NASDAQ peaked at 175. At press time, it stood at a more modest 25.

The data on venture capital investment looks equally reassuring. According to accounting firm PWC, venture capital investment in the U.S. totaled $14.75 billion in the fourth quarter of 2014. That’s the highest figure recorded since 2000, but it still pales in comparison to the first dot-com boom. In the first quarter of 2000, venture firms invested a staggering $28.4 billion — a figure they almost matched in the following three quarters.

“People have learned from their mistakes,” said Mark Zandi, chief economist of research firm Moody’s Analytics. “You had a lot of individual investors speculating on the market in the 1990s. Valuations as a whole were much higher. Today, companies feel more real to me. They, in many cases, have revenues.”

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According to Zandi, real estate tech start-ups’ prospects are looking particularly solid. Unlike some other tech firms, most real estate start-ups generate income. Moreover, the overall size of the commercial real estate industry and its current growth cycle should bode well for start-ups.

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But even though the real estate tech start-up scene appears healthy now, there are threats on the horizon. One is a hike in short-term interest rates, which the Federal Reserve may begin this summer. Low interest rates have helped to promote venture capital investment, since they depress returns on alternative assets like bonds. Although Zandi doesn’t expect venture investment to dry up, he acknowledged that a hike in interest rates could be fatal for some underperforming start-ups.

Perhaps a bigger risk is behavioral. Venture capital firms know that a lot of the companies they invest in will fail. But their behavior is based on experiences from the (often immediate) past. The longer a growth cycle lasts and the more IPOs break records, the more likely investors are to make riskier bets.

“That’s the difficult thing. Ultimately, we reach an inflection point when the failure rate begins to rise and investors update their expectations,” explained Sam Chandan, chief economist of the Manhattan-based Chandan Economics. When that happens, some firms may find themselves starved of cash.

Still, Chandan dismissed talks of a bubble. “I wouldn’t say that many firms failing is a bubble, because that’s the premise on which these investments were based,” he argued. “Failures are predictable, we just don’t know which ones are going to fail.”