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Feeling Free: Since the economy forced them to downsize their marketing company, DMNA owners Stuart Morgan and Todd Diamond chose to donate their extra already-leased office space to artists, rather than have it sit vacant.

Rooms of Their Own

The dotcom bust has left the valley with a glut of available office space--can artists benefit from real estate's woes?

By Loren Stein

RYDER BOOTH concentrates intently as he leans into the upright canvas and carefully dabs the deep red oil paint onto a detailed section of his abstract painting. Music hums, bikes line the corridor and the place thrums with energy and invention. The 31-year-old South Palo Alto resident, a web designer by trade, shares the studio with six other aspiring young artists, each experimenting with their own media and styles: various forms of sculpture, digital photography, paints, oils, acrylics, waxes and plexiglass, among others.

Two months ago, this 2,000-square-foot downtown Palo Alto office space, a hop, skip and a jump from City Hall, lay vacant and dormant, a casualty of the dotcom crash and the economic slump engulfing Silicon Valley and the rest of the country. A year earlier, the building on Hamilton Avenue housed 15 employees of DMNA, an advertising and marketing agency that posted the most billings of any Silicon Valley ad agency in 2001, according to the San Jose Business Journal.

Downsizing and cutbacks forced DMNA co-owners Stuart Morgan and Todd Diamond to vacate the building (their main office is located half a block away) one year ago. Still bound by their lease, the company tried subleasing the space to a small startup, which quickly tanked.

Then Morgan and Morgan and Diamond did some math. With office-space vacancies at an all-time high, there was no way they could recoup the $7 a square foot they pay for the building. At most, the space could fetch a fraction of that, maybe $1 or $2 a square foot.

"At that point, it became a little ridiculous," says Diamond, who along with Morgan is an avid art appreciator.

"We thought, Let's do something good, something more important with this property," he continues. "We decided to convert it into an artists' studio, not just a gallery to show artists' work but a space where artists can create. And we won't charge them a penny."

Specifically, Morgan and Diamond were on the prowl for emerging talent, artists who followed their hearts and not the whims of the marketplace. Culling through 20 portfolios after placing ads and putting the word out in September, they selected seven artists, men and women, whose work they found especially thrilling.

"Honestly, at first we were a little worried that not being in San Francisco we couldn't find cutting-edge artists," Morgan says, who's also a painter. "But we've assembled quite an amazing group." Red Ink Studios, as it's now called, has become "a hive," Diamond explains, noting that the communal space has fostered all kinds of cross-collaborations. "Putting artistic minds together, we were hoping for a kind of creative combustion," he says.

"It's meant everything to me to be here," says Sam Goewey, 27, a waiter and single father who had been painting in his cramped living room in Redwood City. "I've progressed in leaps and bounds."

"Working in a studio environment and being able to collaborate with other people and feed off their energy is a new thing for me," says studio mate Booth, who was also pursuing his art at home. "I'm competitive by nature, so having talented people around me forces me to work harder and be more creative, to do more interesting pieces. Being forced out of this space would break my heart."

There are no promises, however. The artists have signed agreements that the group could be disbanded within a month if the space is needed. If that happens, Morgan and Diamond say they would try to relocate them. As it is, they're taking a $15,000-a-month loss. "Even if we can't continue after six months or a year, we'd love if it we could have helped launch a couple of careers," says Morgan. "That would be the biggest reward."

But the DMNA partners also have a larger vision: convincing landlords who are sitting on vacant properties along Hamilton to offer their buildings, even for short periods of time, for working studios or gallery space. Commissions from sold work could be plowed back into the properties (which is how they hope to keep Red Ink Studios afloat).

So far, the responses have been predictably lukewarm. "They say it's very noble, a very romantic idea, but they're not ponying up their spaces," says Diamond, who would like to see Palo Alto return to its roots as a hotbed of artistic activity, before high rents and high tech drove out the artists.

"A lot of landlords shot themselves in the foot by jacking up rents so high they forced out all the boutiques and creative services," adds Morgan. "Then all the dotcoms disappeared, and now they're left with empty space.

Watch Out for Falling Rents

During the first half of 2000, the height of the boom, landlords throughout Silicon Valley got greedy. Office buildings in downtown Palo Alto, for example, were renting for as much as $11 or $12 a square foot per month. Sand Hill Road, which houses many of the valley's venture capitalists, peaked at $18 to $20 per square foot, says Howie Dalmar, senior vice president for Cornish & Carey Commercial. Now, he says, downtown Palo Alto rents have dropped to $3 or $4 per square foot, and Sand Hill Road to $5 to $7.

"Rents were absurd," says Mark Ritchie, president of San Jose-based Ritchie Commercial Real Estate. In Silicon Valley, office rents have dropped 50 to 60 percent from the mid-2000 peak, he says. "Adjusted for inflation, we're seeing the lowest [office] rental rates in Silicon Valley history."

By the end of last year, the average starting rent in Silicon Valley had fallen to just over $1 per square foot, down from the more than $4 landlords were able to command at the end of 2000, according to Colliers International, a worldwide commercial real estate firm.

Plunging office rents are being driven by a huge glut of commercial office space throughout the valley, which--no surprise--has been hardest hit by the tech crash. Demand for office space fell off in the spring of 2001 after the NASDAQ plunged and dotcom firms started going under, which also forced many of their hardware and software suppliers to abandon their own expansion plans. The 9/11 terrorist attack was a double blow to the sector, coupled with the tumbling stock market.

With the ranks of the unemployed rising, the office vacancy rate in some parts of the valley was as high as 30 percent in the latter part of 2002, the highest in the country. Late last year, Fortune magazine went so far as to describe the local market as "bleak," a "total disaster" and the "most problematic real estate market in the country today," in an article titled "For Lease: One Third of the Valley."

"The 1998-to-2000 boom will never happen again in our lifetimes or our children's lifetimes," says Ritchie. "It was a once-in-every-100-years phenomenon, a very unusual, spectacular bubble."

His firm's downtown San Jose properties are 21 percent vacant, a figure that reflects downtown San Jose's overall market if Sobrato Development Companies' newly built giant office building at 488 Almaden Boulevard is counted. (In media reports, the developer has said the building remains vacant because the company is holding out for one tenant to lease it in its entirety.)

"There was a feeling this area was a little more bulletproof; some industry--defense, telecommunications, networking, then the Internet explosion and dotcoms--was always driving us forward, dynamically, exponentially, but it was not sustainable," says Drew Arvay, managing partner of BT Commercial, a Bay Area commercial real estate firm. "Even now there's biotech, but it's not yet big enough. The impact of this last downturn is that it affected the money, and if you affect the money, you affect everybody. That's what really hit Silicon Valley this last time."

Availability of office and R&D space throughout Silicon Valley now hovers around 20 percent, up from 2 percent in the third quarter of 2000, says Arvay. The valley has seen nine consecutive quarters of a declining market for office space, adds Cornish & Carey's Dalmar. "Why? Because we overbuilt even though we didn't know we were doing it," he says.

In Palo Alto, which has a unique, small-scale commercial real estate market (95 percent of the available land is built out, and most of the buildings are under 15,000 square feet), the vacancy rate for office space went from 12 percent in the first part of 2001 to 25 percent at the end of 2002, according to Cornish & Carey.

"The downturn happened so quickly," says Susan Arpan, the city of Palo Alto's economic development and redevelopment manager. "People were expecting the downturn but not the velocity of the downturn we saw."

"You can have the best space anywhere on the peninsula right now, and even at $2 there's no one there to rent it," says Roxy Rapp, a prominent downtown Palo Alto property owner and developer. "I don't know of any other time in history where there's so much available office, warehouse and R&D space on the peninsula."

All the usual incentives are being offered, says San Jose real estate broker Ritchie, including free rent for three months if renters take on a five-year lease, or cars thrown into the package. "There's no magic potion," he says. In December, he adds, his firm leased 70,000 square feet of full floor space in downtown San Jose. Not bad, he says. But, he adds, "by 2000 standards, that's what you do before breakfast. It's all ancient history, all faded away. We're back to reality now."

Where's the Panic?

In contrast to the last recession of the early 1990s, landlords are not on their knees, at least not yet, even though there's more office space on the market now, which makes matters worse. "The amazing thing about the market is how little distress there's been," says Ritchie. "There hasn't been a lot of foreclosures; there's no panic selling."

The reasons: interest rates are as low as 4 percent, as opposed to 16 to 18 percent during the last crash, and landlords are not overleveraged, brokers say. (Also, they say, some of the savviest, biggest firms sold their portfolios and went out at the top of the market in 1999-2000.) "The interest rates are so low [that] landlords can support their loans on the buildings. But they can only do that for so long," Rapp says.

Rapp predicts that things will get worse this year, meaning fire sales, foreclosures and commercial real estate prices dropping even more dramatically. He believes that available office space in Silicon Valley and the peninsula won't be filled for 10 or even 20 more years, not until another technological revolution sweeps over the valley.

Others offer far less dire predictions. Michael Mullinix, former president of the Santa Clara County Association of Realtors, says that historically there has been a complete business cycle every eight to 10 years, and this one is no different.

"We've followed a very consistent, cyclical, predictable pattern in the last 50 years," he says. "In my opinion," he adds, "we're on the downslide, not at the bottom. It will get worse before it gets better."

Many brokers agree that it will take five years, or until 2008, before the commercial real estate market starts pulling itself out of the doldrums. In the meantime, says Steve Hunt, vice president of Colliers International, "Tenants are moving around, deals are being made and we're still renting office space between 1,000 and 5,000 square feet. But for the landlord with 200,000 feet of empty space, the sky is falling."

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From the January 23-29, 2003 issue of Metro, Silicon Valley's Weekly Newspaper.

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