Before Leasing Space to Internet Companies,
Landlords Are looking at Burn Rates and Balance Sheets
Wall Street investors aren’t the only ones casting a wary eye on dot-coms and other young technology companies. So are Orange County landlords.
While office park owners aren’t turning away dot-coms and other technology companies that have helped drive a boom in OC commercial real estate, they are taking a more circumspect and skeptical approach to these companies.
Just as Wall Street has punished many tech companies for not turning a profit,devaluing their stocks and making it difficult for them to tap new sources of capital,landlords have tightened credit requirements and now ask to see prospective tenants’ financial statements.
“The problem is you don’t know whether they will be around next year, let alone next month,” said John Hall, a broker with Lee & Associates who has represented landlords in lease negotiations with some dot-coms. “It doesn’t take a rocket scientist to see what’s going on with the stock market.”
Landlords Tightening Up
Since March, many technology firms have seen their stocks tumble as investors have grown less forgiving of Internet companies that have yet to become profitable. Many analysts believe a process of weeding out the long-term survivors from the short-term pretenders is playing out.
“(Dot-com entrepreneurs) are re-creating an industry, and that’s where the risk is, whether they’re on the mark or not,” Hall said.
To protect themselves, landlords are requiring dot-coms to increase the amount of their security deposits, either in the form of outright cash or letters of credit from banks.
Parker Properties, developer of the 1.7-million-square-foot The Summit office complex in Aliso Viejo, is one landlord that goes beyond a company’s financial statements in determining whether to lease space.
Recently, Parker Properties was able to work out a deal with eDevelopments.com, a sought-after start-up tenant that is being described by some as an incubator and by others as a company that goes beyond the traditional incubator role. Even with such a coveted company, Parker officials undertook a stringent evaluation of eDevelopments.com’s plans.
Lee Redmond, a principal with Parker Properties who was involved in the negotiations with eDevelopments.com, declined to comment specifically on those talks. But Redmond said that the changing nature of dot-coms has required a more stringent evaluation of young Internet companies.
“The first thing that we typically look at is we want to understand their business, who the sponsors are and what is the expected burn rate of the capital raised and the prospects of raising additional capital,” he said.
Hedging Against Losses
When undertaking these discussions and evaluations, landlords are trying to forecast and cover any potential lost rent in case the tenant is unable to complete the lease. Also in the back of their minds are future improvements they’ll need to make to lure a new tenant and the broker fees involved in landing that new tenant.
To cover these costs, Redmond said Parker Properties might require a tenant to provide a year’s worth of rent, pay for future tenant improvements and leasing commissions. Typically, for a financially strong company with a history of revenue and profits, a security deposit of about two to three months, if that, is all that’s required.
“To the extent they don’t have an operating history, we start to look at ways to enhance the lease,” he said.
Jerry Neitlich, a principal with IN/House Corporate Real Estate, an Irvine-based brokerage firm that specializes in representing tenants, contends landlords are taking advantage of the situation, especially given the high demand for space in places such as Orange County.
“One of the issues that a landlord looks at is how fast (dot-coms) are going through their money,” Neitlich said. “A company may have $5 million in the bank. If they’re burning through that money in 18 months and there’s no back-up funding, where’s the rent going to come from? Landlords probably have some rights to ask for a larger deposit.”
Still, the issue isn’t unique to OC, Neitlich said. In the other tight markets, the risk a landlord takes is tempered by the strong demand for space.
“Let’s look at the flip side,” he said. “In San Francisco, where the market is even tighter than it is here, if a dot-com goes belly up after two years, what is the landlord’s downside? He’s had the tenant for two years on a five-year deal. He’s probablynot put in a lot of tenant improvements because most (dot-coms) are open-planned. How long will it take him to re-lease the space? A month? Two months? Three weeks? So you have to look at what the landloard’s risk is. It may not be as warrented as they make it out to be.”
Whit increase security deposits has come another questions. Who pocickets theinterest that the security deposit generates during the life of the lease? Most states require that landlords keep the security deposit in a separate account. Some mandate that interest be paid to the tenant. In California, no such requirements exist.
“In California, you can co-mingle the money and don’t have to pay interest on it unless it’s negotiated,” Neitlich said, adding that many landlords decline to iopen that subject for discussion.
That’s where letters of credit and other vank instruments ar euseful and can be used as a security deposit.
“For one smalll client, we did a certificate of deposit and make the landlord the beneficiary, so, if there were a default, the landlord could go after the principal,” Neitlich said. “But if everything went fine, the teneant go all the interest.”
As to the length of a security deposit, a middle ground is being staked out there as well in the form of what is being called “burn off” agreements, Neitlich said. That’s where security deposits end up going toward rent if the tenant sticks around.
“I did this with one company where the landlord wanted four months’ security deposit, but we hand one month (designated to) go toward the 12th month of the lease (as rent). A second poriton went to month 18 and so on,” he said. “So the landlord, after two or three years, was left with just a traditional security deposit. That’s probably more resonable. If a landlord thinks a tenent is high-risk, let them performand measure them based on that.”
