Struggling U.S. tech companies are trying to renegotiate leases, seeing rent reductions as a way to free up cash and avoid layoffs.
The CEO of software provider Sendmail lost a $1.5 million deposit when he walked away from a deal to move into an additional 40,000 square feet of office space. Instead, he struck a sweetheart deal with his existing landlord to expand into 72,000 square feet--for one-third the cost of what he would have paid at the new location. The move freed up cash for payroll, international expansion and product marketing.
"Four years from now, we expect to be successful, and $1.5 million should not be that big of a deal," Anderson said of the lost deposit. "We didn't need as much space anymore because of our downsizing, and you can now get space for about a third of what we would have paid."
Although the trend seems more acute in California's Silicon Valley, hundreds of executives in technology corridors around the United States are having chats with landlords to renegotiate leases. Commercial real estate is typically a company's top expense after payroll, so struggling tech firms see rent reductions as a way to free up cash, avoid layoffs and continue marketing campaigns.
Reliable statistics are scarce, but it's clear that renegotiation has become a priority for many companies. One large commercial real estate developer said 25 percent of his tenants have asked him to renegotiate--a higher percentage than he's seen in three decades.
"There's been a surge (of) people who are asking to renegotiate their leases in either the amount of space they're taking or the amount they're paying," said Tim Steele, Northern California director of commercial services for Coldwell Banker Commercial.
The renegotiation trend, which heated up in the second half of 2001, differs starkly from a more ominous string of real estate deals gone bust in the first half of 2001. Sendmail and other companies say they're renegotiating not as last-ditch efforts to remain solvent, but because they survived the 2001 shakeout and believe they'll be long-term tenants--if only they can weather the current economic blip.
Many tenants--particularly cash-strapped dot-coms and technology companies unable to tap venture capital funds--say that the extra cash can help them retain workers and survive for several quarters. They add that the astronomical commercial real estate rates of the late 1990s are over, and the landlords who profited handsomely during the technology bull market can either renegotiate or try to find new tenants for vacant space.
Filling offices is a daunting task in places like Silicon Valley, where commercial vacancy rates nearly quintupled in the past year. The quarterly vacancy rate for office space there jumped from 2.8 percent at the end of 2000 to 13.5 percent at the end of 2001, according to global real estate services firm Cushman & Wakefield.
The art of renegotiation
Many executives in pricey office parks think they should be able to renegotiate because new tenants are getting relative bargains for similar space. It's not uncommon for a Silicon Valley company that leased space in 1999 to pay more than $4 per square foot per month, while a new tenant in the same building pays $1 per square foot.
Roughly 15 percent of commercial leases in the Bay Area were signed in 1999 and 2000--peak years for high rents, according to Curt Setzer, a vice president of San Francisco-based Simeon Commercial Properties. And while five-year leases are common, companies that serve as anchor tenants in a building are usually stuck in leases lasting 10 to 15 years.
The disparity between new leases and those negotiated during the boom days has dramatically reduced the average rental rate for technology companies in Silicon Valley. According to Cushman & Wakefield, the average tech company in the fourth quarter of 2000 was paying $4.28 per square foot per month. The average tech company in the fourth quarter of 2001 was paying $1.96 per square foot per month.
But striking a new deal with a commercial landlord isn't as easy as providing proof that others in the same building are paying less. Well aware of the wild fluctuations in the price of office space, many landlords refuse to cut deals during tough times.
"When the market was on the upswing, no one ever came to my door asking us to raise the rent," said Joe Lewis, president of developer Orchard in San Jose, Calif., which manages seven million square feet of technology office space. "Landlords make financial commitments to their lenders, so they can't say, 'Gee, I feel sorry for you and we'll change your rent.'"
But tenants willing to be creative about renegotiation could find landlords amenable to deals. Companies that have reduced their work forces have returned space to their landlord for sub-leasing, and tenants have moved into smaller offices owned by the same landlord--both in exchange for better lease rates per square foot. Executives have also agreed to assume longer leases in exchange for smaller monthly rates.
"The companies that are the more viable ones and have income and prospects for growth have the greatest chance to restructure," Lewis said. "If they have two years left on a lease and say they will make it a seven-year lease and give a larger security deposit, then the landlord has something to work with."
Sob stories and pity pleas
Some tenants are also appealing to their landlord's sense of pity, telling them that they face bankruptcy or closure if they don't get a break. Carl Berg, chief executive of Cupertino, Calif.-based Mission West Properties, has restructured three leases downward for tenants whose financial health was in jeopardy.
"I had three long-time tenants who always paid their rent on time and were always prompt and fair. But they're in the computer industry and are having some problems," said Berg, whose company manages seven million square feet and oversees 110 tenants. "I agreed to temporarily lower their rent, but we have an agreement that they'll pay us back in the future."
But sad stories and guilt trips won't always result in lower leases. Berg scrutinizes the balance sheets of any company that requests a rent reduction, doling out reductions in worst-case scenarios.
"They think that if they scream enough, they'll get a reduction or be able to get out of their lease," said Berg, noting that the bulk of the requests began two months ago.
Some landlords take a philosophical approach to renegotiation, and are well aware of the power they have over the financial health of their tenants.
"This whole process of negotiating is like the grief cycle," Lewis said. "First, it's shock that their business is doing so bad. Then it's denial, then anger. And then it's acceptance and that's when they usually come to see us."