Someone's dog trots down the middle of the wide-open, exposed brick warehouse space. A pool table sits ready for play next to the receptionist and twentysomething workers worth a million bucks drift in wearing jeans. There's a basketball court, in-house espresso machines and places to just hang out. The floor is concrete, the duct work is exposed and the space costs $65 per square foot.
Welcome to the 21st century office market.
The office market of this boom is different than the last. The formula for success is more complicated. In the 1980s "had to haves" were marble and granite, grand foyers and a double-door entry off the lobby. Now they are telecom infrastructure; open, flexible space; and redundant power. In the 1980s, developers looked to power returns by buying into the building. Now they try to buy shares of tenants' stock. The difference between then and now? High-tech tenants.
The high-tech industry is large, productive and growing exponentially. According to RFA/Dismal Scientist, based in West Chester, Pa., information technology employment accounts for 10% of the workforce and nearly 20% of the economy's output, and both of these measures are growing fast. It is the most important sector of the economy and for the office market.
Steve Lynch, senior managing director of Insignia/ESG in Boston, states simply, "It is hard to hype the influence of the high-tech companies in Boston...the high tech market is the market."
The ascendancy of the high-tech tenant has spread from the traditional tech hubs to places like Omaha, Neb.; Sioux City, Iowa. The promise that some of these tenants hold has not been lost on Craig Panzirer, managing director of Colliers ABR in New York City. "We have been much more concentrated on the dot.com market recently," he says. "If you get in early, you can parlay a small lease into a 100,000 sq. ft.down the road."
But these high-octane tech firms are not standard tenants. High-tech firms have different needs, and owners who want to attract these tenants must understand certain characteristics of the high-tech world and deliver solutions.
Understanding these needs will become more important as the high-tech approach to business jumps industry boundaries to other office users. Many of today's high-tech needs will be the norm before long.
High tech needs...high technology High-tech companies have high-tech needs. If landlords expect to attract and retain high-tech tenants, they will have a sound strategy for supplying high-speed Internet access, redundant power and the flexibility within these systems to grow and change. And they must deliver this in a cost effective way.
Providing these solutions for tenants has made real estate an even more capital-intensive undertaking. Making buildings "high tech" increases both value and risk. Owners must strike the balance between sinking too much money into their buildings and not providing the appropriate infrastructure that will attract high-tech tenants.
The first tech feature many tenants put on wish lists is a flexible telecom infrastructure. "You start out with one floor plan, and when you grow, you need to change the configuration of the office, including the wiring," says Dan Woods, chief technical officer of CapitalThinking.com, a Manhattan-based firm that is currently looking to double its space. "We want a space that is amenable to being rewired without us spending a fortune."
Most of these costs can be passed to the tenant, but in many competitive markets, developers find that their building can earn premium rents by offering state-of-the-art telecom infrastructure and service. Owners may choose to avoid the brain damage and cost of re-wiring and hire third-party telecom companies that shoulder a large share of the expense and create an attractive bundle of services in return for access to tenants.
Supporting appropriate energy management systems is also an important feature for high-tech tenants. These companies use a great deal of electricity and often use it 24 hours a day. HVAC and electrical configurations must be set up to withstand the added load.
There is also keen demand for redundant power systems. Many of these tenants are sensitive to power outages; their networks cannot go down. Some tenants - large ISPs, for example - will set up double or triple redundancy with their own generator pads built outside the building to assure the lights won't go out.
Explosive growth flexibility High-tech firms' potential for explosive and exponential growth has had a dramatic effect on office markets. The potential for a high-tech company to triple its employment in the first year, then triple it again in the second year is creating the need for more versatile office space. High-tech companies need flexibility - in the space they rent and in their leases.
The amount of space demanded by these firms is well known. Most high-tech companies are not willing to go through the normal steps in the leasing process. When they have an opportunity to take down space, they want to close in a week, not 120 days. They move at what some refer to as "Web" or "Net" speed. The furious demand and the fact that high tech moves at a different pace than the rest of the world has tested the real estate industry on its ability to work quickly.
"These tenants' concept of time is much different than the rest of ours," says Steve Lynch of Insignia/ESG. "They like to say that they expect everything four times faster, so they work very quickly, and to get them on board with the glacial pace of real estate has been a challenge."
Filling the high-tech tenants' demand for space - even in the short term - is also a challenge. Owners that provide swing space for tenants within 30 days are at a big advantage. Beacon Capital Partners, for example, has set aside space in its Technology Square building in Cambridge, Mass., for companies waiting for more permanent space.
High-tech tenants have reached the point - as have past drivers of office demand - where they are so starved for suitable space that they are no longer sensitive to price.
"Getting these guys the best deal doesn't always mean the cheapest rent," says Randy Podolsky, principal of Podolsky Northstar Realty Partners, a real estate firm based near. "They want the rights to growif the space exists; they want liberal sublease clauses; and they need the ability to get out from under these leases if they need to. And they want the deal done quickly."
Flexibility in lease structure and floor plan is key. Most high-growth companies incorporate years of expansion into their leasing decisions and look to find twice the amount of space needed. They then sublease the excess until they gobble it themselves. Liberal sublease clauses and space that is partitioned easily are crucial.
Most companies achieve some measure of flexibility by shooting for the shortest lease term they can get. Generally, fast-growing tenants would like a three-year lease, though three years may be a short amount of time from a landlord's perspective. However, given the sky-high rents they are trying to lock in, some owners will take a three-year deal in an existing building. For new, landlords are sticking to 10-year terms.
In most parts of the country, however, lease terms are not entirely negotiable. "This market is really working against many of these companies," says Lynch. "Most of the high-tech markets are decidedly landlord markets, and they are locking in these high rents for as long as they can."
Underwriting Underwriting is one of the significant challenges for owners, lenders and managers in dealing with high-tech tenants. This is purely a new-economy, high-tech issue. Measuring the risks and rewards of renting to so many of these companies is something that landlords have never done before. They are looking at gleaming, enticing double-edged swords. Dot.coms can be out of business in a year, or they can come back to double or triple their space in a year.
The unpredictable nature of these companies is heightened by a lack of traditional financial measures; they often have no operating history and no credit rating. Underwriting these companies demands a different approach, and many firms are circumspect.
"The landlords that I am familiar with in the Boston market are aware of the risks and rewards of dealing with these tenants, and they are taking a measured approach," says Lynch. "There has been increased scrutiny in evaluating these companies. [Owners] have been evaluating both objective and subjective factors, and making some very careful underwriting choices."
Due diligence can be daunting.
"It can be intimidating to research some of these tenants," says Brandon Birtcher, co-chairman and director of development for Birtcher Real Estate Group in Portland, Ore. Birtcher's AmberGlen Business Center in suburban Portland relies heavily on high-tech tenants. "To mitigate risk, we have hired a company that underwrites tenants we can't get our arms around."
Larger companies have set up internal committees to analyze these companies. John Nelly, managing director for Indianapolis-based Duke-Weeks Realty Corp.'s Nashville, Tenn., operations, says, "We have brought a lot of seasoned talent together to form a committee that deals with credit enhancements on dot.com companies and specializes in structuring their leases. The amount of exposure that we have to these tenants is certainly a question that we keep an eye on."
Landlords are not taking chances. They are mitigating risk the good old-fashioned way - cash up front. The industry has been aggressive in collateralizing high-tech leases. Whether owners collect it in the form of options, warrants or letters of credit, the security deposits being requested are outsized and getting bigger as markets tighten and the NASDAQ gyrates.
"Lenders are being very hard on the collateralization of these tenants," says Mona Carlton of Holliday Fenoglio Fowler in. "For landlords to get these deals financed, they are being asked to collect additional security in the form of letters of credit for a minimum of 18 months of rent." Tenants also are usually covering tenant improvements and leasing costs.
Another growing trend is taking warrants or options from the tenant as security or for rental payments. "Landlords [in the Boston area] are asking for some ridiculous rents at some ridiculous terms," says Jaret Christopher, CEO of TrueAdvantage.com. "They are asking for big security deposits, and they are getting them. We also are currently being offered the opportunity to pay lower rents by supplying landlords with warrants."
According to professionals in the Bay-area market, landlords are asking for a warrant per square foot of rented space. That can add up to 3% to 5% of the total value of the lease.
Some believe that real estate is being too unprogressive with some of these tenants. "Landlords are being too conservative or cautious with these tenants," says David A. Falk, executive managing director and principal of New York City-based Newmark & Co. "Think about it. An advertising agency with just two clients is paying $40 a foot and has a five-month security deposit. Who is the bigger risk?"
Whether a landlord is looking to jazz his return or hedging against leasing risk, new-fashioned approaches to underwriting and collateralizing leases are taking place in the market.
High tech changes the workplace As with the dominant finance and service sectors of the past office boom, the high-tech industry continues to drive workplace trends. The high-tech workstyle, an obsession with productivity and the all-importance of the high-tech employee have merged to set the modern office on a new path.
The office market has changed from the regimented corporate standards of the 1980s. The buttoned-up, pinstriped approach to business is loosening hold in favor of a more laid back style of work. "What these companies want to do is build space that feels more like a college campus," says Jane Smith, principal of New York-based Harris Smith Design, a company that has designed space for Jupiter Communications, Webglide.com and TradingEdge.com. "They work in close quarters, and everything is warmer and cozier," she adds. "You can put your feet up. This is a place where no one cares that you are reading a magazine on the job, since they know your were probably in the office until 9 p.m. the previous night."
These workers expect to work a lot. The 9-to-5 work day is an outdated concept; this is a 24-7 culture. "These people often work 18- to 20-hour days," says George Bouris, director of portfolio planning for Palo Atlo, Calif.-based Sun Microsystems. "We actually have a buddy system to make sure our employees go home at night."
The line between work and life is disappearing, and today's high-tech workers have embraced the idea. Ask a high-tech worker how he feels about all of this and he will likely respond with, "Never had more fun, made more money or been so tired in my whole life."
Companies have gone to great lengths to make life at the office more convenient - massages at lunch, on-site dry cleaning and concierges who help with errands. (Seems like "The Man" has finally won out; he just had to be a little more accommodating.)
Management also allows for more individual space where the worker creates a home away from home. "At Mindspring, workers decorate their space themselves," says Jeff Wirt, president of Pasadena, Calif.-based Wirt Design Group. Wirt has an ongoing relationship with several high-tech companies including Earthlink, eToys and Idealab! "There are fish aquariums, Christmas lights...it is very individual space where they are allowed to express themselves."
The design and layout of space also is largely driven by the style of business and the high-tech obsession with productivity. "The whole goal of design for this space is to create space that serves and conserves human energy," says Wirt.
These features range from indirect lighting (less computer glare) to locating an eating and drinking area smack dab in the middle of the room - management realized that is where most employees interact and exchange ideas.
The work done in these offices is highly collaborative, so an open, flexible layout that can be custom fit for employees' needs is important. "These companies are not hierarchies. They are relatively flat," adds Wirt. "This pushes people out of private offices into a more collaborative environment. Very few people have private offices in this world." This puts a premium on space with bigger floorplates.
The average space per worker has shrunk. Private offices are out, and conference rooms of various sizes are in. "Since everything is so open, they need more private, small conference rooms than in the past," says Wirt.
The look of this space is also different - more "honest" to steal a design industry term. Brick walls, natural light, exposed ductwork and steel beams have replaced fluorescent lighting and sheetrock walls. The design firm is an increasingly important member of the high-tech firm's real estate team.
A complete dependence on human capital is one characteristic of the high-tech industry that helps explain the premium that firms are placing on creating the right type of office space.
"Without question, our central asset is our people," declares Bouris. "We have to do what we can to keep these people happy."
That is becoming harder and harder to do. With unemployment below 2% in many high-tech hotspots, managers will go to great lengths to keep their worker bees happy in the hive. And the high-tech workers know it. They don't just check to see if there is an in-house cafeteria, they check if the food is good or not.
A big selling point, naturally, is the work environment. This helps to explain some of the seemingly outrageous accommodations being offered to the high-tech worker. "Internet companies are doing anything they can to attract and keep workers," notes Wirt. "When people come into their offices, they want the prospective worker to think, 'Wow, I've got to work here.'"
E-companies.com has a pool table. Goto.com has an astro-turf putting green. Doubleclick.com's New York office has a basketball court. There is a fitness center at Idealab!. These features are no longer the exception - they are the rule.
All of this comes at a cost, and the money firms are spending to get the right mix of design, amenities and technology appears to be growing. "Each landlord gives some work contribution, and many of these dot.coms are outspending that by 50% to 70%," notes Craig Panzirer, of Colliers ABR in New York.
Well located isn't what it used to be High-tech tenants are not as tied to the suburbs as they were during the self-contained campus rage of the early 1990s. The margin between suburban and CBD prices has narrowed, and, more importantly, there has been a shift in workers' tastes.
"These tenants are much more geographically footloose, and only some of that is dictated by tightness," says Steve Lynch. "For many, it is a matter of appealing to a younger, hip workforce that wants access to 24-hour life near the workplace. In the Boston area, they have even been looking at some grittier areas like Medford and Somerville to get that."
Strict allegiance to property type is fading as well. Any property type will do as long as it results in cool, hip, functional space. While most larger, high-tech firms still prize low-rise space with large floorplates, the search for "cool" space is becoming the norm.
Renovations have been an important factor in providing the type of space sought by high-tech tenants. This alternative space, for a while, was cheaper and scored big points with young, high-tech recruits wanting hip stomping grounds.
Many derelict factories and warehouse buildings that sat idle for decades now are outearning newly developed properties. These rehabs take many forms since "cool" has a lot more to do with what you do with the building than its original use. Schools, firehouses, old mills, abandoned train stations, X-rated movie theaters and strip malls all have been adapted for high-tech use. Old warehouses located near railroads have the added benefit of first-rate access to fiber optics laid near the railroads.
The new drivers of demand for office - high-tech tenants - change the game. The intensity of some of these trends that have been born from the rise of the high-tech tenant may moderate. New office space is being delivered, and the faltering NASDAQ ups the chances for a shakeout for high-flying, high-tech office users. That might take the edge off of rents and security deposits and cancel some of the plans for new, in-house basketball courts, but real changes in the office market have already taken place. These trends will only be more important to real estate professionals as they spread to the broader economy. The clients of these high-tech companies already are adopting many of their business practices and soon the term "high-tech office space" will be just "office space."
Don't think so? Remember the suit and tie get-up you used to wear all the time? One New York broker recently commented that when he walked into a meeting at a dot.com in suit and tie, "They all looked up at me as if I were the FBI. I don't wear a suit anymore."