Equity Office Properties Trust of Chicago, one of the largest commercial property owners in Silicon Valley and the country, announced this week that it has taken a $229 million write-down on 46 properties, including 41 locally, because the leasing market is unlikely to rebound soon.

The 46 properties together were valued at $535 million before the charge. The 41 Silicon Valley properties, all research and development buildings, had a gross book value of $380 million, says Diane Morefield, a senior vice president for investor relations. The company declined to say how much of the write-down related to the valley properties.
EOP's assets at June 30 totaled $24.7 billion.

The company acquired all of its valley R&D properties in its 2001 merger with the former Spieker Properties Inc. of Menlo Park. The write-down follows news that EOP is also working to sell a 5.1 million square-foot industrial portfolio, also acquired in the Spieker merger, to Rreef, a San Francisco pension fund advisor that manages $20 billion in assets for corporate and other clients. All or nearly all of those buildings also are in Silicon Valley and the East Bay.

" Taking an impairment is not good news, but to keep it in perspective, we are only impairing a small percentage of what we bought in the Spieker merger, 5 percent of the dollar value of the original purchase," Ms. Morefield says.

The company paid $7.3 billion in cash and stock, including the assumption of $2.1 billion in debt, for the Spieker portfolio in 2001, which included 38.5 million square feet of offices and industrial buildings, much of it in Silicon Valley. The company said from the outset that it intended to sell the industrial buildings.

Jim Sullivan, a senior analyst who follows EOP for Green Street Advisors of Newport Beach, says the impairment merely formalizes what has been widely understood in commercial real estate circles: "They dramatically overpaid for Spieker, and this is just truing up the values from an accounting standpoint. It's not a surprise that these buildings are worth less than what they paid. They bought at the peak, and the leasing market has tanked, and R&D is most vulnerable to those conditions."
The Spieker merger was the third in a series for EOP, he says, and questions remain about the wisdom of all three.

But Jim Beeger, a senior vice president at Cornish & Carey Commercial Real Estate in Santa Clara, says EOP has fared better than many. "A (40) percent write down ... that's not bad. We've seen some values drop more than that. It's not a home run, but it's not the biggest blunder of all time either."

The company is taking the write-down in anticipation of the properties' sale over then next five years. The buildings are not core assets in the EOP portfolio, which the company defines as multi-tenant, Class A office properties in markets where EOP dominates. San Jose and San Francisco remain core EOP markets.

During a comb through of EOP's entire portfolio, the company identified more properties that it does not believe are core, Ms. Morefield said. Those buildings will also presumably be sold. These are the only ones that required impairment charges, however, "because their (market) values are above their current book values."

The properties were valued generally as though their future use would be as commercial real estate, Ms. Morefield says. However, many R&D and industrial property owners in the valley have been pushing to have their properties' zoning changed to allow residential or retail redevelopment because those properties are so much more valuable today. That was considered in some cases, Ms. Morefield says.

The 41 San Jose R&D buildings have an aggregate of 1.7 million square feet and are located in Santa Clara, Cupertino, San Jose, Mountain View, Sunnyvale, Milpitas and Fremont. The two San Francisco region offices affected, one in Redwood City and the other in Brisbane, have about 180,000 square feet combined. The company did not release any information on their occupancy, age or condition.

Slack tenant demand in the valley for much of the last four years has driven users to the best quality properties available, pushing office users that might have settled for R&D buildings during the boom back into offices. Distinctions between the two property types are not always obvious, however, and it's not uncommon to have significant portions of an R&D building improved to office standards.

The average asking rent for R&D properties today is less than $1 a square foot plus tenant-borne operating costs such as common-area maintenance, down from a high of more than $4.50 a square foot a month in late 2000, according to BT Commercial Real Estate.

Office rents have followed the same downhill slope, going from a peak of more than $6.50 a square foot a month to about $2 a square foot a month, BT shows. The office rents include charges for common area maintenance and the like.

R&D is the most prevalent property type in Silicon Valley, with roughly 2 square feet of R&D buildings for every square foot of offices. There are about 67 million square feet of offices in Silicon Valley, BT says. There are 154 million square feet of R&D buildings.

The write-down is unlikely to have dramatic or immediate market repercussions, several sources say. But commercial appraiser Jeff Fillmore of The Fillmore Group of San Jose says it does emphasize one key fact: "It's a strong signal that a major player in our market doesn't think rebound is imminent."

The tenants, Lovewell said, include law firms, insurance companies, a company that finances tractor trailers and a flooring company.

Bill McCubbin, whose Orion Partners is marketing the Vineyard, said small tenants alone cannot rescue an office market still plagued by falling rents. Instead, economic growth will have to turn small tenants into the large tenants needed to take some of the large available spaces. That could mean a resurgance of the software or telecom sectors or, based on the most recent activity McCubbin has seen, the medical sector.

Indeed, Sutter Health recently took 70,000 square feet at 4000 Civic Center Drive in San Rafael, and Kaiser is said to be in talks to sublease some or all of the 145,000 square feet available in one of three buildings on the campus of Novato insurance company Fireman's Fund, although leasing agent Haden Ongaro of Orion declined to comment.