July 4, 2001 5:00 AM PDT

Tech firms face reality of real estate deals

office complex photo Already hit by a slumping economy, reduced revenues and skittish investors, technology companies are struggling with another malady: real estate deals gone bust.

Some companies such as Palm are canceling plans to build or move into new buildings, writing off tens of millions of dollars in the process. Others, stuck paying astronomical rents that they can no longer afford, are sacrificing huge deposits to back out of the deals.

"All of a sudden, in a very short time, you have a rocket that shot straight up and you now have a rocket that's shooting straight down," said Frank Fudem, senior vice president at BT Commercial Real Estate in San Francisco. "It's impacting the real estate market in a very major way."

While the woes of dot-coms and other tech companies have contributed to the glut, companies that are more on the fringe of the industry are also beginning to feel the pain--raising concerns that the worst is not over.

"At this point, what has happened has moved beyond the high-tech sector into other industries that tend to service high-tech firms," said Chuck Harry, director of analytics at Cushman & Wakefield. "Their businesses aren't growing as dramatically. Decision makers are taking a wait-and-see pattern."

During the boom years of the mid-1990s, scores of tech companies were hiring thousands of employees each quarter, which required them to lease or purchase millions of square feet of space for offices, distribution centers and manufacturing facilities.

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  Tech companies abandon real estate
Phil Mahoney, real estate broker, Cornish & Carey Commercial
But those plans have gone awry in recent months as sales have stalled and layoffs are more common than hiring binges. Dot-coms represent the extreme cases, with dozens simply closing shop after running out of cash, leaving vast amounts of vacant office space in their wake.

Technology companies' busted building deals are reverberating through commercial real estate markets in regions with a concentration of high-tech companies.

For example, after reaching historically low office vacancy rates of less than 5 percent in early 2000, San Francisco and Silicon Valley saw vacancy rates top 10 percent in the first quarter of 2001, according to a report by Cushman & Wakefield.

As vacancies have risen, prices have slipped, dropping 12 percent in the first quarter in some parts of San Francisco, according to the report.

Although demand for real estate appears to be picking up, it will take a while for 9 million square feet of available space in San Francisco to be absorbed, said Fudem. "Even if we did all these (potential) deals tomorrow, it wouldn't put a huge dent in the market."

Meanwhile, Boston's office vacancy rate has jumped from 4.2 percent in the fourth quarter of last year to 10.4 percent in the second quarter of this year, according to Cushman & Wakefield. Northern Virginia, home to tech companies such as AOL, has seen its commercial vacancy rate go from 3.9 percent to 12.1 percent during the same time period. And Bellevue, Wash., home to companies like Expedia and Drugstore.com, has seen its vacancy rate jump from 3.7 percent to 11.6 percent during the past two quarters.

Palm, developer of the Palm operating system and handheld devices, provided one of the most disturbing examples of how ambitious expansion plans can turn into expensive boondoggles.

Last month, Palm announced that it would sell the land that it had intended for its new San Jose, Calif., headquarters. The company reported that halting construction of the headquarters and the decline in value of that property led in part to more than $167 million in charges in its fiscal fourth quarter.

Palm representatives declined to comment.

But Palm is not the only one feeling remorse. Late last year, private e-business services company Groundswell sacrificed a "significant portion" of the $5 million deposit it put down on a 40,000-square-foot space in San Francisco, Dean Alms, company co-president, said.

Groundswell rented the space, which it planned to use as its headquarters, in April of last year for 10 years with a starting rate of $78 a square foot per year, Alms said. The company decided not to move into the space and canceled its contract after the market crash dashed its expansion plans.

The Pleasanton, Calif.-based company now employs 85 people, about half of what it did during the market peak last year and a far cry from the 1,000 employees it expected to have by now, he said.

"In order to secure talent, we needed to be in San Francisco," Alms said. But, he added, the demand for the company's services "dropped off considerably."

Many deposits lost
During the height of the dot-com boom, some real estate companies in the San Francisco Bay Area were asking for deposits or letters of credit from banks that amounted to 12 months to 18 months worth of rent.

Richard Couch, who works with distressed and dying companies as managing partner of Diablo Management Group in Danville, Calif., said at least 15 to 20 start-up companies in the San Francisco Bay Area lost million-dollar deposits in the last couple of years. Companies he has worked with such as Pets.com, Zatso and Riffage.com each lost hundreds of thousands of dollars in security deposits, he said.

"Just about anybody who was in San Francisco in the last two years was looking at very large deposits," Couch said. "You can't blame the landlord. They were trying to market space in a hot market.

"At the same token, the company wants to get that money back because it could make the difference between living and dying."

Other technology companies also provide examples of busted real estate deals:

 As part of a corporate restructuring earlier this year, Amazon.com decided to close down its distribution center in McDonough, Ga., and to operate its warehouse in Seattle on a part-time basis. Amazon took a $114 million charge in the first quarter, in part because of the cost of outstanding leases on those properties, improvement it had made on them and ongoing construction.

 In recent months, Webvan has closed down operations in Atlanta, Dallas and Sacramento, Calif., as part of a plan to conserve cash. The company took a $73.9 million charge in the first quarter, which included the real estate costs involved in the closure of its Dallas operation.

 Earlier this year, Intel announced that it would halt construction of 20 office and building projects worldwide. The company has not taken a charge for the construction, and company representatives declined to discuss how much halting the projects is costing the company. Intel has said it planned to spend $125 million on one 10-story building in Austin, Texas.

 After laying off 8 percent of its staff in January, Excite@Home abandoned plans to move into a 250,000-square-foot office complex it leased in Redwood City, Calif., and is trying to sublease the space. The Internet portal and high-speed access provider took a $5.3 million charge related to exiting its facilities during the first quarter.

 Earlier this year, Inktomi abandoned plans to move some of its staff into a 380,000-square-foot office complex currently under construction in Foster City, Calif. The Web services provider, which subsequently laid off 25 percent of its staff, intends to sublease the building, but has not yet found any takers. Inktomi has already paid for some improvements on the building and is scheduled to pay $324.4 million over the term of the 15-year lease.

To be sure, not all technology companies have been afflicted with real estate problems. The increasing vacancy rates and the decline in some rents has created a buyers' market for those companies that have cash and are looking to expand.

"For tenants, the opportunities are great," said Colin Yasukochi, director of market research in the San Francisco office of real estate firm Grubb & Ellis. "You really have the run of the market in terms of what you want. There's a lot of choices out there."

One company that found that out recently is Equity Thunder. Last month, the start-up was forced out of the office it shared with its incubator and had just days to find a new space, said Michael Spadaccini, the company's general counsel. Despite the tight deadline, Equity Thunder had an easy time finding space, looking at some 20 different offices before settling on class-A, or top-of-the-line, space in Millbrae, Calif., just south of San Francisco.

"We got lucky," Spadaccini said, concerning the softening real estate market. "If it had been two months earlier, we would have been up a creek."

The downturn in the real estate market has been healthy not just for companies such as Equity Thunder, but also for the market in general, real estate analysts say. In the San Francisco Bay Area in particular, real estate prices that reached as high as $80 a square foot were unsustainable.

"A normal business can't pay those rates and expect to make profits," said Mike McCarthy, a real estate broker and senior vice president at Colliers International in San Francisco. "The only ones who could afford to pay those rates were the ones who couldn't afford to make a profit anyway."

News.com's Sharael Feist contributed to this report.

 

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