Some Landlords Take Stock of Net Start-Ups as Rent
It used to be that all a landlord would require from a prospective tenant was a security deposit and first and last month’s rent. Now, a small but growing number of Southern California commercial landlords are asking some tenants to cough up one more item: stock.
The soaring values of high-technology shares and splashy Internet stock offerings find some Los Angeles building owners acting like Silicon Valley venture capitalists. These landlords are willing to reduce rents and loosen their lease terms in return for ownership stakes in what may be tomorrow’s hot high-tech stocks.
The strategy is not without its risks. Some observers say real estate executives are way out of their league playing venture capitalists. Landlords may end up undermining the value of their property by leasing space to tenants with no credit history and no net income.
Landlords are “totally incapable” of assessing the risks, said Jerry Porter of Los Angeles-based Cressa Partners, a broker who represents high-tech tenants. “Therein lies the major difficulty in the do-it-yourself, free-rent-for-stock business. Do you want to turn down [a stable tenant] for a speculative venture?”
But the potential to tap into overnight profits or establish a relationship with a successful and growing tenant has proven hard to resist. Such deals are more common in Silicon Valley and San Francisco, where Internet start-ups continue to blossom and vacant commercial space is a precious commodity. In one dramatic payoff, AMB Property Corp., a San Francisco-based real estate firm, watched its $5-million investment in online grocer Webvan Group, Inc. balloon to $25 million after the start-up went public last fall.
Los Angeles property owners are beginning to get into the act. Many landlords are offering to reduce rents, forgo deposits and provide free office services and even rooftop signage in return for the right to buy stock in their new tenants, according to lawyers and brokers working on several deals. Even one of Los Angeles’ largest and most prominent real estate companies, Beverly Hills-based Arden Realty, is jumping into the game.
“There’s a lot of talk and the deals are starting to happen,” said real estate attorney Robert Plotkowski of Advisors LLP. There is the “possibility for a landlord with a conservative . . . investment in real estate, to make an astronomical return in the equity invested in their tenant.”
Many tenants, however, are not too thrilled with the idea of giving up valuable equity to pay the rent. Jim McDermott, founder of Archive.Com, which is involved in the online storage of information, said he was able to raise enough to pay for his lease on 6,000 square feet of office space near Westchester. He wonders about the viability of firms that could not attract sufficient venture capital to pay their rent.
“If you had a viable idea . . . then you would have financing behind it,” McDermott said. “You would use that financing for real estate.”
Real estate executives say they can team up with experienced venture capitalists to help determine the prospects of a new company and reduce risk. New York-based TechSpace, for example, has formed a partnership with Safeguard Scientifics Inc., a venture capital firm, to invest in some of the tenants that lease space in its high-tech incubators. In addition to a 40,000-square-foot complex in Manhattan, TechSpace will soon open offices in Boston and San Francsico and is looking for space on L.A.’s Westside, company founder Debra Larsen said.
Venture capital is “certainly not my background,” said Larsen, a former commercial leasing specialist. “That is why we brought in these strategic partners . . . who can spot a good deal when they see one.”
Arden Realty will also rely on venture capitalists to help it size up potential tenants and investments. The firm will not drop its rental rates, but a few select tenants will be allowed to pay for a wide variety of services--from equipment rental to bookkeeping--with warrants. (Warrants give the holder the right to buy stock at a specified price.) The company will start the program with some of the tenants moving into its 22-story Westwood Center, the former Monty’s Building, which was recently renovated.
Those warrants may one day be valuable securities. But they are not expected to have a major impact on the company’s bottom line, Arden President Victor Coleman said. Arden’s main interest is in establishing a relationship with promising companies that might one day need large amounts of office space, he said.
“That’s where we feel the value is,” said Coleman, whose company is seeking warrants in negotiations with a handful of potential tenants.
AMB Property said the major payoff from its investments is an insight into how e-commerce will help or hurt different kinds of commercial property, President W. Blake Baird said. The company’s investments include stakes in online gift company Red Envelope, specialty retail incubator Brand Farm and grocer Webvan.
“Our shareholders are pleased with the financial rewards, but that’s not the main driver,” Baird said. “It’s really about getting to know how change will affect work processes and real estate values. It’s almost like [research and development] spending.”
So far, AMB Property’s most valuable lesson: Speed is more important than storage.
But the urge to cash in on the high-tech boom might backfire on landlords who fill up their properties with high-risk ventures instead of more credit-worthy tenants, said real estate consultant Kenneth H. Townsend at E&Y; Kenneth Leventhal Real Estate Group. That could scare off conservative investors and reduce the value of their buildings when they go up for sale.
“This whole area is fraught with pitfalls,” Townsend said.
