Silicon Valley's Commercial Real Estate Glut

Imagine 15 Empire State Buildings, all of them sitting empty. That real estate broker's nightmare comes to more than 43 million sq. ft., which is how much commercial space stood vacant in Silicon Valley as of the end of the third quarter, according to CB Richard Ellis Group (CBG). And though vacancy rates in the Valley have not reached the levels seen in the wake of the dot-com bust, property owners may be worse off today. That's because many defunct Internet companies back then continued paying rent through the venture capital firms that funded their leases. Now Valley players that have survived the hard times are fighting for—and in many cases winning—sizeable discounts on rents that are already off some 20% from last year's levels.

By some estimates the rate of commercial foreclosures in the Silicon Valley area will at least double in 2010. That works out to about $1.5 billion in foreclosed properties, according to data compiled by New York-based research firm Real Capital Analytics. "Many of these assets have lost half their value," says Real Capital managing director Dan Fasulo. "That's a bloodbath."

California's info tech sector has lost more jobs in the past year than any other except construction and mining, state data show. Unemployment in the San Jose-Sunnyvale-Santa Clara metro area hit a two-decade high of 12.1% in August and has since eased only slightly, to 11.8% in November. Applied Materials (AMAT), Sun Microsystems (JAVA), and Adobe Systems (ADBE) have announced more than 5,000 layoffs since October amid falling sales of computer chips, software, and equipment. Even stalwarts like Hewlett-Packard (HPQ) and Cisco (CSCO) have pared back their workforces over the past year to safeguard profits.

Meanwhile, developers added more than 4 million sq. ft. of speculative office space in the Valley since 2007, building gleaming towers on the expectation that startups would move into classier digs as they matured. Now 21% of the area's top-of-the-line office space is vacant, as is 20% of low-rise so-called flex space that can be adapted for offices or manufacturing, reports CB Richard Ellis. Some buildings in downtown San Jose, such as the Riverpark Tower II, a 318,372 sq.-ft. high-rise completed in July and owned by Foster City (Calif.)-based Legacy Partners Commercial, and a 381,000 sq.-ft. tower that Oracle (ORCL) acquired in the 2008 takeover of BEA Systems, sit empty. Legacy is showing the building to prospective tenants, says Lisa Morrissey, vice-president of marketing. Oracle didn't return calls seeking comment. "None of those towers will fill up anytime soon," says Jon Haveman, co-founder of Beacon Economics, a consulting firm in San Rafael, Calif.

Asking rates on Class A office space averaged $34.56 a square foot in the third quarter, a 21% drop from a year earlier, while rates on flex space averaged $14.16 a square foot, down 16%, according to CB Richard Ellis. That's great news for the likes of Facebook, which signed a lease on roomier quarters in December 2009. The company's new Palo Alto home will span 265,000 sq. ft. across four low-rise buildings that once housed the lathes and centrifuges of a medical device manufacturer. "We're at the end of a bubble," says Stephen Levy, director of the Center for the Continuing Study of the California Economy in Palo Alto. "It will take a long time to get the momentum going."

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