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The Counselor - April, 2000

What's it mean for real estate?

How should real estate respond to e-commerce? We're all asked this question more and more frequently, and yet the landscape changes on a daily basis. The mid-year Toronto meeting to get the CRE perspective. But sitting in a hotel room, working on a laptop, linked to the internet, my bank, and my office, I wonder how it can't have an effect.

Real estate's long-term nature is a difficult match to the transition that internet commerce has brought upon us. One landlord I know has a suite, built and leased to an internet startup. The buildout went smoothly, the tenant signed off, and the rent checks come in a few days early every month. The only hitch - Nobody's ever moved in. By the time the 45-day buildout schedule was complete, the company was 30 times larger and had an entire building to itself down the road. As to the original space, all that remains is a monthly check.

So how does one underwrite e-commerce deals? A lease is an investment in the tenant, and should be viewed accordingly. An obvious concern is long-term viability. Peapod's recent woes illustrate this. But an equally relevant question is, will these companies survive success?

When the e-commerce transition is complete, we may know what the market wants. But until then, finding a balance between short-term opportunity and long-term risk will remain a challenge.

There are relevant parallels. A few years ago, I invested in a biotech firm that made genetically engineered tomatoes. Their tomato doesn't rot immediately after it ripens, the way regular tomatoes do. It's vine-ripened, and shipped ripe. I bought shares shortly before FDA approval, and saw a nice 50% run-up in the space of two weeks when the approval came through. But after approval, this was no longer a biotech company. It was a tomato company. And the tomatoes it sold were, it turned out, more expensive to pack and ship, and went through different channels. They ripened without rotting, so they could be vine-ripened, instead of being picked as green billiard balls and then gassed when ready to sell.

This looked like good news back in the R&D stage. But once it turned into a tomato company this meant that it had to buy equipment used for picking and packing peaches, and use different, more expensive distribution channels.

It was, forgive the pun, a great biotech firm, but a rotten tomato company. I sold out at a 50% loss, and was lucky to get it. Of all the no-earnings, no assets e-commerce flyers out there, the question is not how many will fail, but how many will survive success?

Copyright 2000 - Noah Shlaes