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Telecom chip maker PMC-Sierra took a $102 million loss earlier this month when it sold a vacant Silicon Valley office tower.
Like many firms, PMC was stuck with surplus real estate when the tech boom went bust and the economy soured. PMC had been leasing the 12-story building in Santa Clara, Calif., but bought it to get out of a 10-year lease that would have cost it $215 million through 2011. PMC didn't need the building, so it sold it at a loss just to get the property off its books.
The PMC deal and a host of others speak to the problem of unused office space and other excess real estate. Empty offices and warehouses and idle land have been a burden for companies nationwide. The glut may not begin to ease until 2005, experts say.
Tech-heavy markets like Boston, Dallas and Silicon Valley have been hit particularly hard.
But there's a silver lining. The availability of office space and other facilities creates opportunities for entrepreneurs to house start-ups and for healthy companies to get additional space on the cheap. But that's not good news for companies holding the real estate, many of which paid top dollar during the bull market, and have seen its value tumble since.
Reality Sinks In
Many firms that had been holding on to surplus real estate, hoping for things to improve, are now capitulating.
"You're seeing companies coming to the realization that things aren't good, they're not getting better anytime soon and it is time to cut their losses," said Phil Mahoney, executive vice president with Cornish & Carey Commercial, a Silicon Valley real estate firm.
Fiber-optic gear maker JDS Uniphase Corp. is another recent example. In June, it sold five research and development buildings totaling 280,000 square feet in Silicon Valley at "distressed sale" prices, Mahoney says.
Some top-performing companies are taking advantage of depressed real estate prices, he says. This month, Internet search-engine company Google Inc. subleased 500,000 square feet from Silicon Graphics Inc. for its new Mountain View, Calif., headquarters. And online auctioneer eBay Inc. recently bought 500,000 square feet of office space in San Jose, Calif., from Novell Inc.
"It's clearly a tenant's market and will be for some time to come," Mahoney said. The real estate market needs the economy to improve and companies to start hiring again before it recovers.
The office vacancy rate in Silicon Valley is about 25%, with more than 65 million square feet sitting empty, Mahoney says. The percentage could be 35% if you consider shadow space, which is space that companies are holding even though it is not being used.
Shadow space could contribute to a further decline in the real estate market. That's because many high-tech companies that signed five- to seven-year leases in 1997-2000 plan to exit some of that space when their leases are up. Such firms are now just biding their time, says David Lester, president of tenant representation firm G&L Realty in Dallas.
"It looks like 2005 is going to be a horrible occupancy year for landlords," Lester said.
The Telecom Corridor in Richardson, Texas, home to a large concentration of telecom firms, has been devastated by that industry's fall. Nortel Networks Corp., for instance, has dumped 700,000 square feet of office space in the Dallas area in the last two years, Lester says.
Three years ago, Nortel was leasing prime space for $21 a square foot. In December, it sublet a full floor of a building, 25,000 square feet, for $10 a square foot and threw in furniture, telecom equipment and utilities to boot, he says.
As much as 50% of the office space in Telecom Corridor is idle. Of that, 20% is available directly from landlords, 20% available for sublease by tenants and another 10% is in shadow or ghost vacancy, he says.
"It's going to be a two- or three-year problem," Lester said.
The tech and telecom boom, fueled by the growth and promise of the Internet, was a once-in-a-lifetime event that left a large overhang of available office space.
That's led to many creative real estate deals.
For example, Palm Inc.'s hardware unit leased an office park from Cisco Systems Inc. last August for its new headquarters. Cisco included furniture and networking technology, such as a Wi-Fi wireless system. Cisco also built a cafeteria and meeting space on the campus to sweeten the deal.
"They realized that they had to put amenities in place to be able to try and lure corporate users," said John Igoe, vice president of real estate for Palm Solutions Group.
Cisco had consolidated some of its locations and no longer needed the space. It leased three buildings to Palm.
Palm was going to build its own headquarters, but scuttled plans when the downturn set in. It's holding on to vacant Silicon Valley land it owns.
"We've taken our hit," Igoe said. "We went out and got it appraised at the current market and got it written down."
Silicon Valley may have a lot of "see-through buildings" now - meaning no people or furniture are inside to block the view - but the real estate market appears to be stabilizing, Igoe says. "All the craziness relative to deals being offered is starting to temper now."
One of the biggest challenges to unloading commercial real estate is just getting potential tenants to look at your space, says Jeff Vines, director of real estate for health care products distributor McKesson Corp.
"If you're in a place that has 50% vacancy rates and you're a broker representing a tenant who wants 5,000 or 10,000 square feet, you've got 75 or 100 opportunities," Vines said. "You're not going to show them all."
Companies often have to offer incentives to get brokers to recognize their space. They also use aggressive pricing and amenities to get noticed by prospective tenants.
Nationwide, 14.7% of office space in the top markets was vacant in the first quarter, says CoStar Group Inc., a provider of electronic commercial real estate data. It was 13.8% a year earlier, 10% two years earlier and 8% three years ago.
The highest vacancy rates in the country are in Dallas/Fort Worth (20.4%) and Raleigh/Durham (20.2%), CoStar says.
To make matters worse, property owners nationwide are still constructing office buildings that were greenlighted during boom times.
Corporate real estate officials are not optimistic about a quick turnaround.
"The data are not portraying a recovery," said Richard Kadzis, director of marketing and communications for CoreNet Global, a professional association for corporate real estate executives.
Member surveys indicate that companies are planning to use less space in the near future. In its May survey, 51% of respondents from the real estate industry said they planned to decrease their own office space in the coming quarter vs. 46% in February. Only 16% said they planned to increase office space, unchanged from the earlier survey.
"It's not a good view of the economy right now. It could mean that we still haven't bottomed out," Kadzis said.
Though availability of cheap office space is creating opportunities for start-ups, it won't solve problems for companies with a lot of empty office space. Entrepreneurs are taking space in 15,000-to-20,000-square-foot increments, Palm's Igoe says.
That's not enough volume to absorb all the real estate on the market now and expected soon. If the economic recovery continues, real estate will bring up the rear. "The next group of entrepreneurs out there will have some pretty nice pickings for a couple of years," Igoe said.
But real estate measures such as occupancy rates are lagging economic indicators, meaning they're among the last to improve.
Office space isn't the only real estate in excess now; factory space also is idle. Capacity utilization rates are at 20-year lows in the U.S., says Ed Yardeni, chief investment strategist and a managing director of Prudential Securities Inc.
"There seems to be an enormous amount of excess capacity in so many industries," he said. In May, factory capacity use was 74.3%. |
