For many overspent dot-com tenants, things are much worse. Some have already been forced into bankruptcy, in part by lease commitments they could not afford. Healthier Internet companies with decent cash reserves are waking up with a real estate hangover that is certain to be a drag on their bottom line for years: Leases on idle office space now rank among the top liabilities for many companies.
For a dot-com seeking San Francisco office space in 1999 and 2000, the consuming emotion was panic. Their business plans called for rapid growth, but they had nowhere to put employees - they needed space, any space, and price be damned. Landlords, enjoying the rare luxury of picking and choosing among prospective tenants, pushed the unproven newcomers as hard as they could.
"Getting your client in the front of the line was difficulty No. 1," says Kevin Brennan, a senior VP at Staubach & Co. "You had to sell the dream." Brennan succeeded in selling his client, Atlanta-based consulting firm iXL, to a landlord, but not before the company's chief marketing officer flew in to tout its potential. In June 2000, iXL got its 105,000-square-foot lease at 575 Market Street. The terms were onerous: $82 per square foot, a 15-year commitment and two years in rent up front in a letter of credit - essentially a security deposit of about $16 million.
Experts say Internet companies showed the same naivete in dealing with leases as they did in other areas of their shaky businesses. Few had experienced real estate managers, and the highly strategic job of managing space needs often fell to the CFO, says Martha O'Mara, a lecturer at the Harvard School of Design who advises large companies on real estate matters. "CFOs don't know anything about corporate real estate," O'Mara says. "They took advice from their brokers ... Hello?" Brokers get paid a commission based on the initial value of a deal, not on whether the lease is completed, O'Mara notes.
Against that backdrop, you could say iXL rival Organic got lucky: It found enough space for a massive planned expansion of its San Francisco headquarters in November 1999, just before the real estate market boiled over. Back then, Organic's revenues were soaring as it signed on new blue-chip clients such as DaimlerChrysler and Blockbuster every week. Organic was on track for a $110 million February 2000 IPO. It found an entire building in the SoMa area. The site's 212,000 square feet would be enough to house about 850 workers - more than the company employed worldwide. And Organic paid a not-too-pricey $40 per square foot.
Still, the 10-year lease amounted to nearly $85 million - a steep sum for a company with 1999 revenues of $78 million and losses of $39 million. Organic promptly proceeded to improve the space, hiring a top architectural firm for the roughly $10 million job, or about $50 per square foot in improvements, according to building owner Ronaldo Cianciarulo.
