Space for rent; Downcycle hits telco real estate in New York – Industry Trend or Event
The near-full capacity of prime telco hotels such as 111 8th Avenue and 60 Hudson Street in New York notwithstanding, the boom in telco real estate is over. Co-location firms are dropping like flies, service providers are trying to fill data centers with customers, and real estate barons who thought they were going to make millions housing server racks are desperately searching for non-telco tenants.
Brause Realty of New York knows the glut problem too well. For months it refused to re-up tenants and bore the cost of a vacant building so it could turn a Long Island City property into what it called the Bridge Plaza Tech Center. But its plans went awry, and the company wound up renting the entire building to MetLife insurance company.
The firm could not find a telco tenant whose creditworthiness was on par with MetLife’s, said David Brause, vice president of Brause Realty. “The intent all along was to have a mixture of office uses and telco uses,” he added, saying the firm did not lose money on the deal.
“There’s very little [telco] demand right now, and there’s excess capacity,” said Robert Stella, senior vice president and managing director of commercial real estate brokerage firm CB Richard Ellis.
And it will get worse – especially in Manhattan, the epicenter of the telco real estate world. That’s because supply in Manhattan will increase from “shadow space” that is becoming available on the market, Stella said. Shadow space is real estate that’s been leased and is technically off the market but has not been occupied or built out for its intended use, Stella said.
‘Everyone kept saying the demand was there, but it wasn’t. These companies expanded beyond what was practical from a profit and loss standpoint.’
– Robert Stella, CB Richard Ellis
About 900,000 square feet of this space could become available in Manhattan in the next month, Stella said. Level 3 Communications, for example, doesn’t have enough business to fill its co-location center at 85 10th Ave. Co-location firm Globix bought a building on Greenwich Street that is less than 20% occupied, and Exodus Communications has committed to 350,000 square feet of space at 635 11th Ave. but has yet to build it out. Digital Island is in a similar situation in Brooklyn.
“Everyone kept saying the demand was there, but it wasn’t,” Stella said. “[These companies] expanded beyond what was practical from a profit and loss standpoint.”
On the secondary market, telco real estate is becoming available for a song. The assets of co-location provider Colo.com – which buckled under a $360 million debt load and went bankrupt – are attracting bids in the $50 million range. The company’s 25-facility network cost Colo.com almost $400 million to build.
Not everyone agrees there is a glut, however. The New York metropolitan area, the San Francisco Bay area, Washington, D.C., Dallas and Atlanta have healthy supply-demand characteristics, said Henry E. Blount, Internet infrastructure services analyst at Lehman Brothers. “Only Boston, Los Angeles and Miami face serious overcapacity challenges,” he wrote in a recent report (see figure).
According to a joint study by Lehman Brothers and Cushman & Wakefield, which examined telecom capacity for the top 30 U.S. markets, operator lease rates for existing telco real estate appear to be holding steady in most markets despite the slowdown in demand, a situation that would also argue against a glut. “The big hotels are still $120 to $250 a square foot,” said John Kane, CEO of gigabit Ethernet provider Telseon. “There are waiting lists of existing tenants who want to expand their footprint in a space.”
The telco real estate market has been efficient in responding to “oversupply situations,” Blount said. For example, Level 3 Communications canceled a planned 800,000 square foot data center in Washington, D.C.
“We like to be the owners of our own buildings because landlords tend not to be nice to carriers,” said Chris Kenny, director of product management for Level 3. There also was a good amount of carrier space available from partners, Kenny said.
As in the competitive local exchange carrier market, the present safe havens in telco real estate may actually be in the second- and third-tier markets where demand is lower but there are also fewer competitors.
InFlow, a managed hosting provider, expanded to 18 data centers in the past two years by leasing facilities for 20- and 30-year terms in second-tier telco markets. It concentrates in areas such as Atlanta, Pittsburgh, Denver and Philadelphia. “The [telco] real estate development that happened in the last five years has enabled InFlow to get to market more quickly,” said Jim McHose, InFlow’s chief financial officer.
InFlow has leased about 600,0000 square feet of raised floor space and about 250,000 square feet of that is being actively used. Four of InFlow’s data centers are cash-flow positive, a milestone that takes about 18 months to reach from the time operations start.
“The trend lines are our friends – the demand for e-commerce applications continues to increase on a month-to-month basis,” McHose said. “And we don’t see capital flowing in that’s going to drive the development of new data center space.”
InFlow has hedged its bets however, by splitting its data center leases among telco hotels and less specialized commercial buildings. Although InFlow has no plans to cancel any of its leases, it’s often much easier to get out of a lease in a general purpose office building than in a telco hotel, McHose said.
“The corporate real estate market is very tough these days,” he said. “Anything you do to limit the prospect of someone taking over your leased space is not going to help you.” In some cases, the only alternative is subleasing, which is driving down telco real estate prices as much as 15% to 20% below their peak in the third quarter of last year, Stella said. “They’re paying rent on something they’re not getting a return from,” he said. “[The amount of their] losses depends on when they signed their leases.”
The factors in favor of supply and demand stabilizing involve rising barriers to entry in the co-location and hosting markets, Blount said. For example, the anticipated power crises in New York and California mean many utilities are increasingly unwilling to connect power-hungry carrier hotels and data centers to the grid.
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