Headline: Telecom Slump Has Offices Full of Dead Air; About half the space converted nationwide for switching stations and data centers is said to be vacant.

Source: Los Angeles Times, 5 July 2001

URL: http://www.latimes.com/business/20010705/t000055237.html

It was only a year ago that the owners of many empty and run-down downtown buildings across the country were leasing and selling space at top dollar to rapidly expanding telecommunication firms.

But the hard times that have hit telecommunication businesses have caught many landlords with too much supply and little if any demand.

Nearly half of the 46 million square feet of buildings converted for use as high-tech switching stations and data centers are vacant, according to a nationwide survey by the real estate firm Grubb & Ellis Co. Once-sky-high rents are falling fast as operators of fiber-optic networks and related companies react to a steep drop in demand and many teeter on the edge of failure.

"We just built too much supply," said Mike Gerard, national director of Grubb & Ellis' telecom group. "It is just as bad in New York and Chicago as it is in L.A. and San Jose."

Demand for space, which ballooned overnight after the deregulation of the telecom industry in 1996, is expected to eventually pick up again. But few expect a return to the red-hot pace of years past.

Downtown and central Los Angeles, where more than 2 million square feet of space was converted for telecom tenants in just a few years, has fared better than most other markets. But the dynamics have changed as requests for space have plunged from more than a million square feet to less than 100,000 in the last nine months, forcing some landlords to search for alternative uses for nearly vacant buildings. About 35% of the telecom space is empty, according to some estimates.

"The market just disappeared," said broker Mark O'Brien at CB Richard Ellis Services Inc.

Though many downtown Los Angeles telecom properties are fully leased at lofty rents, numerous projects that are still in their early phases of leasing or in the planning stages are stuck in limbo:

* The former University Club building in the heart of downtown remains an empty, six-story shell despite its prime location near the crossroads of the city's major fiber-optic transmission lines.

* A 350,000-square-foot warehouse south of downtown Los Angeles was sold last fall to a New York group that immediately began looking for telecom tenants. So far, no major leases have been signed, according to brokers familiar with the property.

* In the mid-Wilshire area, Fowler Flanagan Technology Partners is looking beyond telecom tenants to fill the 22-story Wilshire Technology Center. Despite upgrading electrical systems and making other improvements, the partnership has leased only four floors of the former insurance company office building, said the building's leasing director, John C. Anthony of Charles Dunn & Co.

"We are looking at residential or standard office [uses] to keep the income up until the telecom market comes back," he said.

There really wasn't much of a telecom real estate market until the telecom industry was deregulated and Internet use began to surge. The conditions proved to be an unexpected blessing for the owners of buildings located near major fiber-optic transmission lines.

Telephone companies, new fiber-optic carriers and upstart telecom and Internet firms entered a mad rush to set up switching stations and related operations as close as possible to the lines for the best connections. The favored locations were in downtowns where hubs of national and international transmission lines made for quick links between carriers.

As a result, what were once considered run-down properties--ranging from century-old office buildings to failed shopping malls--were transformed into choice pieces of "new-economy" real estate.

"It was going to be the savior of every vacant building in every downtown in America," said Paul Brindley, senior director in the Los Angeles office of Holliday Fenoglio Fowler, a commercial real estate loan broker. "Everybody was building these things to accommodate future growth."

In downtown Los Angeles, long-vacant office buildings near the One Wilshire building--a longtime hub for transmission lines--were leased at rates that easily topped those of prominent skyscrapers.

"They didn't care about the rent," O'Brien said of the telecom tenants.

Historic landmarks, such as the former Robinsons-May department store on 7th Street and the Terminal Annex postal facility near Chinatown, also "went telecom," as real estate brokers say. The flood of conversions was so great that city leaders proposed an ordinance limiting the practice for fear the new facilities--often staffed by skeleton crews--would undermine efforts to attract new restaurants and retailers.

"They were here and now they're gone," Central City Assn. President Carol Schatz said. "The regulation is not necessary at this point."

The dot-com bust, a slowing national economy and overly optimistic industry growth estimates have forced many telecom tenants to put expansion plans on hold. Last month, for example, Broomfield, Colo.-based Level 3 Communications Inc. said it will eliminate about 1,400 jobs as revenue falls below forecasts.

Level 3, which amassed about 6 million square feet of space for its data centers in three years, now will focus more on services that distinguish it from rivals than on real estate, said company executive Alex Cioth.

"We are taking a more prudent approach in terms of where we acquire space and how we acquire space," Cioth said.

Though the long-term prospects for telecom service firms are bright, the surviving companies are expected to adopt a more conservative approach to real estate when the economy rebounds. The need to expand will be tempered by a growing willingness to share facilities and the ongoing miniaturization of equipment, which will require less space. Also, the expansion of fiber-optic lines into suburban areas might mean less demand for downtown locations.

"Everyone just overestimated what the demand would be," said Gerard of Grubb & Ellis. But "over the long term this is a growing market. It's not going away."

-- Andre Weltman (aweltman@state.pa.us), July 05, 2001

Answers

The next shoe to drop in commercial real estate could be a telecommuting business response to high energy prices and high operating pass through costs.

What sense does it make for a backoffice worker to commute 45+ minutes to work each day to sit at a PC connected to a modem when they could do the same job from home. The savings of x sq.ft. of leased space, plus y $/sq.ft. operating cost, plus commercial office furninture is substantial.

-- Tom Beckner (tbeckner@erols.com), July 05, 2001.