By Michelle Lerner
Despite the recent roller coaster for high-tech company stock prices, real estate supporting this sector continues to thrive.
When Bookham Technology, Inc., a company headquartered in the United Kingdom, was recently looking for a location for their United States headquarters, they chose to lease a property in suburban Maryland. Following the lead of hundreds of other high tech companies, Bookham Technology, a company which designs, manufactures and markets optical components which allow communications networks to be built for Internet traffic, chose to locate near a major city and in an area which has already attracted other firms in technology-related fields. These clusters of high tech businesses have also attracted the attention of REITs, many of which are investing in areas dominated by technology companies.
A Diverse Profile
While most people would quickly identify the Silicon Valley, suburban Boston, and the Northern Virginia suburbs of Washington, D.C. as areas dominated by the high tech industry, this industry is certainly not confined to those areas nor can it be identified as a monolithic entity. High-tech companies include hardware and software manufacturers, biotech companies, and telecommunications companies.
"The traditional definition of the high-tech industry used to mean companies that built computers and computer chips, but now it stands for a much broader field," said Stuart Rothstein, chief financial officer of Spieker Properties, Inc. "High-tech companies don't all act the same, and there's not only a difference between hardware and software companies, but there are also differences between companies within those areas. The high-tech industry is not some mass of companies which operate in lock-step with each other or have the exact same needs."
Seeking Solid Real Estate Investment Characteristics
Given the amorphous quality of the high tech industry, many REITs are focusing their investment strategy on a broader set of criteria rather than chasing just the technology companies.
According to Rothstein, "Obviously we look for what we think will be the most financially secure areas in which to invest. The two factors that determine where we invest are supply and demand, and we specifically look at what are the dynamics which keep supply under control and what drives the demand in any particular area. The high-tech industry has been a big driver of demand in today's economy."
Spieker Properties is heavily invested along the West Coast, owning and operating over 40 million square feet of commercial real estate in California and the Pacific Northwest.
"Our company has chosen to invest on the West Coast in part because the supply of commercial real estate here is relatively constrained," said Rothstein. "The land is not that abundant and there are government issues as well, both of which make it more difficult to develop more commercial space. On the demand side, the population is growing and employment and innovation are taking place in this area. As for the high-tech industry, in the long-term it continues to be the greater part of this country's GDP and where most of the early stage capital investment takes place. But the companies we lease to could be biotech companies, technology firms, or financial companies. It doesn't really matter as long as we are comfortable that that type of demand can be expected to continue in the future."
According to Steve Walsh, vice president of capital markets for Carr America Realty Corporation, his company also concentrates on job growth and supply constraints.
"Certainly the high-tech industry is a big part of the demand equation, but investment decisions are based on a broader set of factors than just one industry. We are heavily invested in Austin, Texas, the Bay Area, and D.C., all of which have a lot of telecommunications and software companies, because that's where the jobs have been created. But investment decisions are predicated on the fact that buildings can be used for a lot of different tenants. Obviously credit is important as well, we certainly need to know we are leasing space to a viable company," said Walsh.
Growth Demographics Are Key
Corporate Office Properties Trust, a REIT invested primarily in the Washington-Baltimore corridor, focuses on good demographics in general when making their investment decisions rather than looking at only the high-tech industry.
"Our company made the strategic decision to focus on the Baltimore-Washington corridor because the demographics here are right for growth, but we also have a diversified tenant base, not just high tech companies," said Sara Grootwassink, vice president of finance and investor relations for Corporate Office Properties Trust. "Our corporate strategy has been to go into submarkets where we can be a larger player in the office sector and we've found tremendous economies of scale and benefits to this."
Washington Real Estate Investment Trust, the oldest REIT in the United States, also invests solely in the Washington, D.C. area, and shares the corporate strategy that by staying a local operator they can operate more effectively.
"The greater D.C. [which includes the Northern Virginia and Maryland suburbs as well as the District of Columbia] area is the number one high-tech employment center in the country, so even though only a small percentage of our tenants are high- tech firms, this has indirectly affected our company," said chief financial officer Larry Finger. "The high-tech industry has helped to create one of the hottest and tightest real estate markets in the country. We feel this area has the best of both worlds, because the federal government provides stability and protection in case of a recession, and the high tech companies are here to provide growth.
"On the retail side, the impact of the high tech industry has also been indirect. For example, out in the Dulles [airport] Corridor, the Dulles Town Center shopping mall has been built mostly because of the tremendous residential growth in that area. The residential growth has occurred because land prices in that area are cheaper and also because of the high-tech employers nearby. People want to live near their jobs if they can," Finger said.
High-tech companies tend to cluster near large and medium-size cities, in part because these areas also attract highly educated potential employees, and, as Grootwassink puts it, people want to be near their peers.
"In an economy with a four percent unemployment rate companies chase employees, not the other way around," said Rothstein. "If a business wants to attract top level managers and engineers they need to be located in Boston or the [San Francisco] Bay area or Northern Virginia because the balance of employment is in favor of the employees right now."
One part of Bookham Technology's decision to locate in Columbia, MD is the presence of well-educated, qualified potential staff members in the area, as the company plans to eventually hire as many as 1,000 new employees.
The high concentration of engineers in the Baltimore- Washington corridor was a key component in their final building selection, according to Andy Quinn, president of North American operations for Bookham Technology, Inc.
The greater Washington, D.C. region has been particularly attractive to some companies because of the proximity of the federal government. According to Deloitte and Touche's "Technology Fast 500" list, this region has the highest number of fastest-growing technology companies in North America, with 50 firms based in the D.C. area, compared to the second-highest number of 38 in Boston, followed by 35 in Silicon Valley. The region also climbed from 12th place to 4th on Fortune Magazine's listing of the Best Cities for Business, which cited the D.C. area for its growing Internet, telecommunications and optical-networking companies as well as its life-science industry.
"Washington, D.C. has attracted so many high-tech companies in part because a lot of the technology has been created as an outgrowth from the federal government," said Finger. "The Internet was originally created by the Pentagon as a military communications device. Defense contracting is a huge business in this area, and a lot of that involves software development. It was natural for these companies to branch out to private sector work. This area obviously has lots of highly skilled workers, and the high-tech companies want to be located where they know they can find skilled employees. Also, lots of firms are concerned about federal regulations and want to be near the government. For instance, MCI located here to be closer to the FCC. Also, Tysons Corner has one of the two Internet hubs in the country. All Internet traffic must go through either of these two hubs, and the closer you are to either one the cheaper it is to operate."
The sophisticated technical capacity required by high-tech companies is available in virtually all modern buildings, so modifications are usually not required when leasing to a high tech firm.
"Over the past few years most office buildings have needed to be able to handle advanced telecommunications equipment such as fiber-optics or satellite dishes on the rooftops," said Rothstein. "All companies, not just high tech companies, need as much of a communications package as they can get. High-tech companies used to be innovative with their use of open office space. Other types of companies do this now, too, so office space has become more generic."
Computer Data Centers
Computer data centers, which house computers and other high-tech equipment but typically employ only a few workers, are attracting attention in suburban areas which see the centers as beneficial forms of economic development generating tax revenue but little traffic or other environmental hazards. But in Washington, D.C., a moratorium has been placed on building the data centers because of the concern that these often window-less spaces would slow revitalization in some parts of the city.
"No one knows for sure how much space will eventually be needed for these data centers, but in the long-term they will likely be significant users of space," said Finger. "As more and more people use the Internet all the time, more of these data centers will be needed, but who knows how much? However, I do expect Washington and the Northern Virginia suburbs to have a major percentage of the business of these data centers."
Computer data centers are one area in which the high-tech industry continues to grow, and, while many investors expect a short-term slowdown in the high-tech world, they still anticipate long-term growth. While investors in individual high tech stocks might have been clenching their teeth while watching the NASDAQ roller coaster of 2000, investors in REITs were not experiencing that same level of stress. Even though many REITs have chosen to invest in areas dominated by the high-tech industry, their investments do not depend on a company's daily net worth.
"People need to realize that whether or not Microsoft stock prices go down doesn't mean that Microsoft can't pay their rent," said Walsh. "On a looking forward basis we will be looking carefully at new companies' credit and their ability to pay, but we've always been conservative in that aspect."
Pushing Rental Rates
The high-tech industry's growth has had an impact on keeping occupancy rates high in some markets, which in turn has helped rental rates to increase. According to CB Richard Ellis Global Research & Consulting, the expansion of the technology sector was a major factor in pushing rents, and therefore total occupancy costs, higher in many major markets in the U.S, including Boston and Los Angeles, which had their lowest office vacancy rates in recent history. The average annual occupancy costs in San Francisco shot up during the first six months of 2000 to propel that city into the list of the Top 10 most expensive markets for office tenants in the world, the first time an American city has made that list since the company began tracking global records.
"The rental rates increase purely as a result of supply and demand, and it depends on where you are located," said Rothstein. "We saw the greatest growth in the beginning of 1999 and into the early part of 2000, but now most rents have moderated or plateaued, which is tied to the general slowdown of the economy."
Identifying areas of future expansion for the high tech industry is the subject of a study researched by Merrill Lynch in June 2000, which ranked markets according to where the high tech companies are conducting their business and which parts of this business sector are growing the fastest (see box). But most REITs will continue to focus their investment strategy on the tried-and-true practice of analyzing supply and demand in all fields, not just the high tech industry.
Michele Lerner is a freelance real estate writer from Reston, VA.
