Since then, Organic has hit the wall. Revenues have plummeted, forcing the company to lay off hundreds of workers. Its headquarters are nearly three-quarters empty, and the company is attempting to sublease 140,000 square feet. So far there are no takers. That represents a minimum of $5.6 million per year in rent for space that is collecting dust. "They pay the rent every month," says Cianciarulo, adding the two sides are in discussions to resolve the issue. And that's just one of Organic's buildings. Worldwide, Organic has long-term leases worth a whopping $198 million, according to its most recent annual report.
Real estate planning snafus like Organic's can quickly turn into a company's biggest liability. After all, excess employees can be fired and unsuccessful product lines can be cut short. But leases linger. Consider iXL, which recently laid off scores of employees and closed offices around the country, including its nine floors at 575 Market.
IXL negotiated its way out of its San Francisco lease, and neither the company nor landlord wants to discuss the terms of the settlement. But in regulatory filings, iXL listed restructuring charges of $76.6 million tied to the recent layoffs. Of that sum, a remarkable $65 million is linked to lease losses and write-downs on office improvements. And iXL faces an additional $41 million in restructuring charges over the next several quarters.
While some dot-coms paid immense sums because the demand for space far exceeded supply, many were blinded by the notion that there was no such thing as risk: A downturn was unimaginable. (Standard Int'l. Media, parent of The Standard, was among the companies that rented considerably more space than it ultimately needed.) In April 2000, eGroups, a community e-mail company with about 175 employees, snapped up eight floors at 555 Market Street, the building next door to iXL. The 125,000-square-foot space would give it room to grow to about 400 people, according to former CEO Michael Klein. The privately held company signed a 10-year agreement at $57 per square foot - a total lease of about $71 million. Even though the rent was costly, Klein thought eGroups would either use the space or rent it to others for a profit. "At the time of the transaction, we had other companies that wanted to sublease from us," Klein says. "We were thinking it wasn't going to be too difficult to find someone to take it."
The space now sits empty. Yahoo took on the liability for the rent when it acquired eGroups in June 2000 for about $428 million in stock. Yahoo spent months negotiating a way out of the lease and will pay a "modest" restructuring charge, according to spokeswoman Shannon Stubo. While Yahoo managed to wiggle out, building owners with cash-rich leaseholders have little incentive to play ball. "Landlords are pretty happy to sit back with the knowledge that they have a creditworthy tenant on the hook and a huge deposit," says Dan Mihalovich, founder of real estate firm Mihalovich & Partners. Like Yahoo, NBC might be acquiring an enormous real estate headache as soon as it absorbs online affiliate NBCi, which signed some $88 million in long-term leases for space that is mostly empty throughout San Francisco.
Smaller companies are hurting even more. Defunct Internet access firm Spinway, for instance, had a crucial $2.5 million tied up in a real estate deposit before it shut down, says Martin Pichinson, CEO of Sherwood Partners, a crisis-management firm that handled Spinway's closure in December 2000. "You are talking about a lot of money" that represented a substantial part of the capital available to Spinway, he adds. In most cases, real estate costs alone are not sufficient to pull a company under. But they have often tipped a company into bankruptcy. "Some people are threatening bankruptcy to try to negotiate down the rent," says Doug Van Gessel, a partner in real estate law at Brobeck, Phleger & Harrison in San Francisco. Leases, he adds, can be the major stumbling block for a company seeking new financing. "Most everybody who comes to me and says they want to negotiate a lease termination [does so] because their VCs won't give them additional financing unless they can get out" of existing leases, Van Gessel says.
During the first nine months of 2000, the vacancy rate for office space in San Francisco was near zero, and rents on top space surged from about $50 per square foot to more than $80 per square foot. Today, virtually every block of SoMa has at least one For Lease sign clamoring for attention. Some have more than half a dozen. Entire buildings that were refurbished for dot-coms are empty. Vacancy rates have soared to 10 percent citywide, according to Grubb & Ellis, and have a reached a staggering 26 percent - and rising - in SoMa.
