The race by Chicago’s new Internet companies to lease downtown office space this year seems to be marked more by fits and starts than get-up and go.
In January, the Internet firms were ready to lease everything in sight, and they wanted it all right away. Three months later Wall Street soured on tech firms, and Web-site businesses started retrenching — even though most weren’t old enough to dig trenches in the first place.
“When it came time to actually do the deals, a lot of them were never done,” said Stephen Smith, a senior vice president with Jones Lang LaSalle Inc., a Chicago-based real estate services company. “And those that were done were a lot smaller.”
The step-on-the-gas, slam-on-the-breaks pace is just one of the ways that the local real estate business is being influenced by the dot-com sector.
Other pressures created by these upstarts include a very old-fashioned dislike for high rents, a fresh affinity for trendy locations outside of the Loop, and a nerdish love for technical requirements such as uninterrrupted electrical power.
Most experts see dot-com tenants having a lasting impact on the real estate business.
“While tech companies are raising the bar for office infrastructure, every company is using technology more than ever,” said David Gelfand, senior managing director in the Chicago office of tenant representation firm Julien J. Studley Inc.
One high-tech trend that has not made it to Chicago is landlords taking stock warrants in start-ups as security for the cost of constructing the interior space, instead of the traditional letter of credit.
If the tenant went in the tank, the warrants would be worthless and the landlord would be stuck with construction costs. But if the tenant went public, the landlord would be rewarded for the greater risk of leasing to a fledgling firm.
Yet it’s unlikely a single warrant deal was ever done here, said several real estate experts.
Not only do most landlords cringe at such deals, but entrepreneurs are reluctant to give up precious equity just for cheaper office space.
And, of course, the April dot-com downturn didn’t persuade anybody that this was a good idea.
Even in the much-vaunted home to Internet start-ups, California’s Silicon Valley, stock warrants are a supplement, not a replacement, for a letter-of-credit as security, said tenant representative Gregory Gerber, a veteran Chicago broker.
He recently spent 17 months in San Francisco as Studley’s western regional manager before returning to Chicago in June as a senior vice president with John Buck Co.
“Office space is so tight there, it’s being auctioned off,” he said. “If two companies are bidding for the same space, warrants can sweeten the deal.”
Yet lease security remains one of the largest real estate problems facing Internet firms, a problem made worse because their space is more expensive to build.
Even though they avoid fancy, wood-paneled suites, their offices usually cost more because of the increased wiring and greater need for air conditioning to cool the computers.
A typical office can range from $35 to $45 per square foot to build, while an Internet company’s space can range from $40 to $60 per square foot, said Michael Clune, president of Chicago-based Clune Construction Co.
Yet new firms are loath to tie up their precious capital with a letter of credit when they could be spending it on expansion.
Subhash Bedi, chief operating officer of EthnicGrocer.com, said, “If I have just $12 million, and I have to tie up 10 percent of it in a letter of credit, then that lease is a non-happening deal.”
In January, the Internet retailer of specialty foods signed a lease to move from its 8,000-square-foot office in Evanston to 1 N. Dearborn St.
But the deal nearly collapsed over the letter of credit requirement.
Enter the Daley Administration, which had been courting EthnicGrocer, to step in with a novel proposal, offering to place city funds in escrow as partial security. It’s the only such deal the city has done, and maybe that’s a good thing, given Web-site firms’ subsequent, sudden downsizing.
Tenant after tenant walked away from deals, culminating in Divine InterVentures’ August decision to back out of a lease for more than 350,000 square feet of space in E-port, the former Montgomery Ward catalog building on Chicago Avenue.
Other prominent collapsed deals: Digitalwork.com’s 140,000-square-foot lease at 175 W. Jackson Blvd.; and Visanow.com’s 30,000-square-foot lease at 33 N. Dearborn St.
EthnicGrocer was not immune. After signing a lease for 50,000 square feet, the company planned to quickly use an option to double its space, but ended up backing away. And several more deals were downsized or dropped.
“They (start-ups) can hurt you from a credibility standpoint,” said Michael Klein, executive managing director of the Chicago office of real estate service firm Insignia/ESG Inc.
But Internet companies have few established benchmarks to help forecast their expansion, said Bedi of EthnicGrocer. “The growth can be very unpredictable, depending on the consumers and the capital markets,” he said.
To conserve capital, dot-coms look to cut costs on rent, usually preferring older buildings with rejuvenated telephone, electrical and heating-and-cooling systems.
Clearly, tech firms are at the forefront of broader changes in the way office work is done. Every business is using more phone lines and more power. As a result, landlords of existing buildings are constantly upgrading their properties. And the developers of new buildings are locked in a technological arms race.
The latest contestant to enter the chase is 550 W. Jackson, a 420,000-square-foot building under construction on the edge of the West Loop.
Developed by Mark Goodman, the 18-story structure will provide at least 7.5 watts of electricity per square foot, twice the amount of power that was common 10 years ago.
And the building offers a closet for telephone wires, called a riser, that has more than seven times the capacity of the 10-square-foot riser found in many older buildings, said the president of Chicago-based Mark Goodman & Associates Inc.
The latest gizmo: a natural gas-powered generator for back-up electricity. Goodman said he is working on financing for that feature, which would add about $3 million to the more the $70 million cost of the project.
While the latest technology makes Goodman’s project competitive with other new buildings, and with other projects, he said he isn’t sure every tenant cares..
“Companies where the senior people are in their 30s are very appreciative of what we are doing,” he said. “I’m not sure the rest of the market has evolved to that point.”
