Caution Enters ‘Dot-Com’ Office Market
The shakeout in “dot-coms” is starting to ripple through Southern California’s office market, resulting in a breakdown of some lease negotiations and a widespread clampdown by landlords that is forcing Internet businesses to curtail expansion plans.
The shift, still very early, has yet to have a broad measurable impact on vacancies or rents, which have steadily improved with the strong economy.
But clear signs have emerged in recent weeks of slowing demand by dot-coms and increasing reluctance by landlords to support the industry’s hunger for office space, especially in hot markets such as the Westside.
In Santa Monica, for example, Cliff Goldstein said that he was negotiating with three dot-coms about their move into 80,000 square feet of space at the new Water Garden II building. But when the stock market plunged last month, the deals collapsed.
Though other firms, including Sony Music, quickly signed up for the space, Goldstein, a partner in building owner J.H. Snyder Co., said he is growing increasingly skeptical of companies that are banking on profits five years from now.
His new tenant policy: No more than 20% of the building will be leased to dot-coms.
Other landlords have taken equally stringent measures, requiring many dot-coms to guarantee payment of up to three years’ rent through letters of credit and other means. Some have hired accountants or other financial advisors to evaluate a prospective tenant’s ability to turn a profit and commonly use financiers to evaluate potential tenants.
“We’re certain that a substantial percentage [of dot-coms] will fail, but we aren’t sure which ones,” said James McWalters, chief executive of PM Realty Advisors, a Newport Beach equity capital fund that manages $1.9 billion in real estate. “The general viewpoint in the institutional community is one of great caution in regard to dot-com firms.”
Rapidly growing technology companies looking for big blocks of space to rent in Southern California became a key driver of demand, leading to widespread changes in the real estate market. Many landlords, despite their concerns about the stability of such companies, were eager to accept the new tenants.
Technology companies often need to expand quickly into larger quarters, so they want assurances that landlords will be able to provide the space or will release them from long-term obligations. Landlords wanted assurance that these tenants would be around for the typical lease period of five to 10 years and often passed on the cost of improving the space to the tenants.
But some building owners have grown more than just cautious, said Tony Natsis, a Los Angeles lawyer who reviews lease agreements between tenants and landlords. He said some landlords no longer are leasing to Internet start-ups that don’t have deep pockets or major capital behind them.
Michael Dubin, director of facilities at ECompanies, a Santa Monica business incubator, sees reasons for concern.
“There have been numerous deals that have fallen through either because landlords couldn’t get the credit they needed from the tenants’ financial statements, or the tenants are smarter now, and saying, ‘Wait a minute, let’s think about what we’re doing here in the first place,’ ” Dubin said.
In Orange County, broker Kevin Hayes has begun encouraging dot-com clients who can’t meet landlord credit standards or can’t afford rental rates to sublease space from companies that need less room. Hayes, who manages Staubach Cos. in Orange and San Diego counties, said tenants desperately seeking to reduce their lease payments would more readily accept a dot-com firm, despite the lack of a credit track record.
Since the tech-heavy Nasdaq market suffered its worst one-day loss ever in March, several brokers said lease negotiations in which their clients were involved abruptly ended.
One dot-com was barely more than a signature away from completing a deal to double its space to 40,000 square feet in a Westwood office building, said Vincent Pellerito, a broker with Cushman Realty Corp. in Los Angeles. The vacancy was the last open space in the building, and canceling the deal would probably mean the company could not later expand without moving to another building.
But the market gyrations “scared the client, and he decided not to take the additional space,” Pellerito said.
Dot-coms also are hesitating to pay steep rents, hampered by the strongest real estate market in more than a decade. Leases in posh areas of West Los Angeles and Orange County have topped $4 per square foot per month, and vacancies have remained well below 10%.
“Before, the tenants were overpaying for leases and . . . didn’t care because they were desperate to secure space,” said Robert Plotkowski, who advises several Internet firms on real estate matters. Now, “they want to make sure the economics of the deal make sense. It has definitely cooled the market.”
In West Los Angeles, for instance, Ken Deemer, the president of high-tech investor group Tech Coast Angeles, said he has been helping a company look for 5,000 to 10,000 square feet of space in West Los Angeles for three months.
“We can’t find anything,” he said. “Landlords can name their own price and they’re getting it.”
The tight market means that many firms are eager to take advantage of any dot-com deals that crumble. For example, several entertainment and media companies are waiting to see if money-losing online retailer EToys Inc. might give up some of the 151,000 square feet of space it has leased in the Westside Media Center, a new building under construction, said Nick Christensen, a CB Richard Ellis broker.
“They’re anxiously waiting on the sidelines,” he said. EToys spokesmen did not return calls seeking comment.
Rather than lease a space that may take them a few years to fill, some dot-coms are staying put in smaller spaces where rents are lower, brokers said.
Those with broader expansion plans, meanwhile, have adopted a different strategy. More firms have been relocating new Internet businesses to less prestigious, but lower-priced office space.
In El Segundo, in Culver City and on Century Boulevard near Los Angeles International Airport, prospective tenants can pay $1 to $2 less a square foot for the same amount of space than in higher-rent districts, though they will be farther away from health clubs, coffee bars and other amenities they look for in properties, real estate brokers said.
“A lot of them didn’t want to go downtown,” said Paul Nadel, a principal at East-West Capital Associates. “But now they are willing to do it simply because it’s cheaper.”
Times staff writer Jesus Sanchez contributed to this report.
