Lost in Space

Excess real estate is a growing financial burden. But some companies are creatively filling their vacancies.

Inktomi’s eyes were bigger than its stomach. Like other presumptuous technology companies in the Bay Area, Inktomi Corp. binged on real estate in the late 1990s, signing a 15-year lease on a nearly 400,000-square-foot office complex, a $300 million commitment for a partially built edifice that it would never occupy. “We were a voracious consumer of office space,” sighs Randy Gottfried, CFO of the Foster City, California-based provider of Web search services.

Inktomi’s ravenous appetite was stimulated by the company’s nearly 30 percent growth rate per quarter from 1998 to 2000. But when the economy slowed, the company was left bloated with a long-term lease. “This was a tremendous drag on earnings, having a $300 million commitment hanging over our heads,” Gottfried laments. “It was also very distracting — it’s what investors wanted to talk about all the time.”

The only way out was to sign a lease termination with the landlord, Chicago-based Equity Office Properties Trust. However, due to low demand in the Bay Area — vacancy rates hover at around 15 percent — that wasn’t going to happen cheaply. “We ended up giving them $40 million in cash up front, plus another $10 million in cash equivalents and stock,” the CFO notes. In preparation, the company took a $75 million charge to second-quarter earnings. The deal was struck in September, yet the now-completed buildings remain vacant.

Across the country, the number of similar vacancies is staggering. In Silicon Valley, more than 45 million square feet of commercial real estate — roughly one-sixth of the Valley — sits empty, according to commercial real estate information services firm CoStar Group Inc. In Manhattan, more than 20 million square feet of excess sublease space is now available. And there are few signs of relief: a survey in November of 1,000 member companies of CoreNet Global, an association of corporate real estate professionals, found that 42 percent of companies are planning a net decrease in the amount of space they will occupy in the next six months.

Little wonder that write-offs related to real estate have soared. Sun Microsystems took a charge of $365 million related to surplus real estate, while Nuance Communications has a lease loss that may total $69 million over the next 10 years. Such decisions, explains Robert Willens, managing director at Lehman Bros., reflect “that the real estate is unproductive and permanently impaired, and is carried on the books in amounts unrealistic given the [real estate] market and the company’s ability to use the space.”

Some companies view write-offs as the easiest way to deal with that inability. But rather than go that route, Cisco Systems Inc., The Boeing Co., and others are thinking outside the cubicle to solve their excess real estate problems. Strategies range from donating buildings to dickering with local communities over zoning regulations to doing what Cisco recently did with 150,000 square feet of unused space in San Jose, California. “We bundled in our own IP technology to make the space more attractive,” says Cisco spokeswoman Sandra Wheatley.

Vast Wasteland

Sweetening the deal often makes the difference in this market, which has no shortage of prospective buyers. “These days there’s a flight of capital from equity to real estate, which is yielding between 7.5 percent and 11 percent — a hell of a lot better than the stock market,” says Michael Silver, president of Equis Corp., a Chicago-based real estate advisory services firm. Moreover, says Harold Bordwin of Keen Consultants, headquartered in Great Neck, New York, when the last real estate crunch occurred 10 years ago it was accompanied by a credit crunch. “That isn’t the case today.”

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