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Corporate Collapse: Discounted Space

As More And More Large-Scale Corporations Fall Apart, Smaller Companies Are Benefitting From The Vacancies Left Behind In Buildings And Facilities.

By Steve Bergsman

UNITED STATES Filter Corp. (USFilter) claims the title of North America's largest water firm, but that pedigree hasn't put it beyond the safety zone of corporate tomfoolery. Its parent company, Paris-based Vivendi Universal SA, went on a huge buying spree in the 1990s, evolving from a water utility into the world's third-largest media company - But now it's time to pay the piper. Struggling under a mountain of acquisition-related debt, Vivendi fired its chairman and under new leadership, it is broadly divesting to relieve the debt load.

The big problems of a French conglomerate seep all the way down to even small-town USA. USFilter owned a 72,199-square-foot building in Marshall, Mich., but economic troubles forced them to put it on the block. Fortunately, it was just the kind of property Team Tube Ltd. of Canada was looking for - It acquired the building for $1.5 million, to be used as a steel warehousing and distribution center.

Even Vivendi, which is a huge corporate mess at the moment, hasn't reached the dismal depths of degeneration attained by such American companies as Adelphia Communications, Arthur Andersen, Enron, Global Crossing, or WorldCom, all of which have entered into bankruptcy proceedings and/or are being dismantled.

These companies and other smaller corporate disasters, particularly in the telecom sector, once occupied millions of square feet of space around the country. Much of this space is coming back on the market, creating opportunities for expansion and for entrepreneurial firms to occupy Class A space at substantially reduced costs.

According to a Wall Street Journal report, Adelphia occupied 2.2 million square feet of space, with big concentrations on Long Island and in Tampa, Fla.; Arthur Andersen occupied 3.3 million square feet of space, with a large concentration in Chicago being vacated; Enron occupied 1.3 million square feet (its headquarters was in Houston); Global Crossing occupied 1.1 million square feet, with a significant amount of space in Madison, N.J., and Southland, Mich.; and WorldCom owns 8.4 million square feet of endangered space that can be found in places like North Dallas; Alpharetta, Ga.; northern Virginia; and St. Charles, Mo.

While most of the empty space can be categorized as office, this abundance of empty buildings also includes warehouses, distribution facilities, R&D/flex buildings, and telecom hotels.

Today, large companies have more corporate real estate listings than ever, says Brad Cohen, president of Los Angeles-based Cohen Asset Management Inc., which acquires, owns, and manages office, industrial, and distribution facilities across the country. Cohen often looks for sites in secondary or tertiary locations. "Companies like WorldCom have several large facilities in tertiary markets, including a brand-new facility in Alabama on which it spent $190 million and [that] now sits empty."

In 1999, Cohen Asset Management acquired the former Elmgrove campus of Eastman Kodak in Rochester, N.Y., renaming the five-million-square-foot property Rochester Technology Park. The repositioned office and technology park is now home to Heidelberg Digital, Lightwave Enterprises, and Pitney Bowes.

Earlier this year, Chesterton Blumenauer Binswanger (CBB), which offers a full range of real estate services internationally, represented an unnamed bankruptcy trustee in the sale of a 330,668-square-foot building on 127 acres in Quincy, Mass. Speedrack Products Group, a supplier of pallet racking and storage systems, bought the facility and is upgrading it to meet the company's specific manufacturing requirements. More than 200 jobs will be created when the facility becomes operational. CBB also handled the aforementioned sale of the USFilter building.

There are so many excellent, functional properties in these secondary markets, says Cohen, "and we will be seeing these kinds of properties coming into the market for a very long time."

Effect on the Markets

Companies in retreat or that have already collapsed have let go legions of employees, and the amount of space coming back on the market for sublease has been tremendous, according to Robert Bach, national director of market analysis for the Grubb & Ellis Co. in Indianapolis. On the office side, sublease space now totals 135 million square feet, while industrial sublease has risen to 60 million square feet.

The industrial market began to stabilize in the second quarter of 2002 and the frequency of vacancies decreased. Los Angeles County, for example, counted 3.2 million square feet of sublease space at the end of 2000, says Bach. This jumped to 14.8 million square feet by the end of 2001, and through second quarter 2002 there has been only slight backtracking to 13.7 million square feet.

In places as disparate as Atlanta, Cleveland, Minneapolis, and San Antonio, warehouse and distribution vacancies are now in double digits. If a tenant is looking for bargains, time is running out. "It seems the worst is over for industrial sublease space," says Bach. Unlike the office market, the demand for industrial space is not driven as much by employment factors. Companies may occupy a huge distribution facility, but they are populated by just a small number of employees in relationship to the amount of space.

On a national basis, the cost of renting warehouse and distribution space peaked at $4.99 per square foot in the first quarter of 2001, and it has since fallen by 3.5 percent. This is not great, but it is a considerably more stable market than office, where rental rates have declined 15 percent over a similar period of time.

Some office markets that have been particularly hard hit by scandal-plagued corporations include North Dallas, with a vacancy rate of 30.2 percent; Atlanta, at 18.8 percent; Houston, at 16.2 percent; and northern Virginia, at 15.2 percent. Even some lesser markets have been affected. WorldCom boasted a concentration of space in St. Charles, Mo., which lies northwest of St. Louis. That market, according to the Wall Street Journal, now holds a vacancy rate of 45 percent.

Some of the aforementioned cities will get worse before they get better. Two particularly troubled markets are Houston and northern Virginia. The growth of the northern Virginia corridor, outside of Washington, D.C., has been dominated in recent years by the rise of the telecom and communications sectors. Office space in the region totals 140 million square feet, of which 15 percent is empty, reports Paul Schweitzer, an executive vice president for Julien J. Studley Inc. in its McLean, Va., office.

The rise in vacancies has been concurrent to the decline in rent. "It has dropped dramatically from its peak," says Schweitzer. "For instance, in Tyson's Corner [Va.] the average rent for Class A space peaked at about $36 to $38 a square foot. Now, that same space is trading at $22 to $24 a square foot. Out in Herndon [Va.] we have seen the same kind of reduction in rates."

WorldCom has "enormous" space in northern Virginia and it has been consolidating, says Schweitzer. A pair of buildings it owns in Pentagon City has been put on the block, with some big investors such as Tishman Speyer Properties Inc. circling about. One building that changed hands was a 300,000-square-foot project in Arlington, Va., that was acquired for $62 million by another big investor, Beacon Capital Partners. That building had been owned by Qwest Communications International Inc., the troubled Denver-based telecom.

The northern Virginia real estate market didn't suffer very much from the big corporate disasters, says Schweitzer, but it was definitely hurt by the decimation of the telecom sector. Two companies that once held a large amount of space in the area were Teleglobe Inc., which has sought protection from creditors while it restructures debt, and Winstar Holdings LLC, which has filed for bankruptcy protection.

On the other hand, the city of Houston's real estate problems have been a direct result of corporate disasters - the Enron scandal in particular, which also brought down Arthur Andersen, a major downtown Houston tenant, and affected Dynegy Inc., another big employer in the city.

There is approximately 28 million square feet of Class A space in downtown Houston. By the second quarter of 2001, that market experienced a 95 percent lease-up. By the beginning of 2003, the vacancy rate should increase to about 20 percent, largely due to three companies, according to Peyton Collins, an executive director with the Insignia/ESG realty firm in Houston. Arthur Andersen will give up 350,000 square feet and Dynegy will vacate 100,000 to 200,000 square feet. Once Enron is thrown into the equation, nearly three million square feet will be vacated around the start of 2003.

Enron also occupied space in suburban office parks where it had a back-up facility, says Collins. "Rates are now about $25 to $27 a square foot gross, which is cheap for Class A space, and you could probably get one of the nicest buildings constructed in the Southwest."

Variable Space

While all of the space becoming vacant in downtown Houston is classified as office space, for those firms who can get a handle on alternative uses there are some real surprises, explains Collins. Enron was building a call center with backup, cable, and computer lines already hooked up. It is five floors with 50,000-square-foot floor plates. Collins notes that a building located somewhere 30 miles outside of town is often an ideal space for a call center.

Then there are Enron's backup tech centers in the suburbs, which are almost turnkeys for a company with strong technology requirements. In addition, Enron's support companies that are occupying industrial space of all types are beginning to vacate.

In the northern Virginia area, most of the vacated buildings are also offices. "There is not a ton of industrial space because there is no manufacturing and distribution here on a wide scale," notes Schweitzer. However, there are a number of data centers sitting empty because they were built for tenant companies that don't exist anymore.

After September 11, 2001, regional firms began to take another look at data centers and other vacated space. "One of the things that came out of September 11 is the need for enhanced security and backup systems for government and private-sector companies. We are seeing some leasing, especially by larger users, where the space is being converted into hardened disaster centers," says Schweitzer. "There is good activity in that sector of the market."

A large amount of telecom space was built at $500 to $750 a square foot, and if it is not used for telecom-hotel carrier space, then the market value of that space drops to $125 to $250 a square foot, notes Bradley Hall, national director of strategic services for Ernst & Young in Los Angeles.

The key is adaptability, Hall adds, and being able to see how a building can be used differently. A 124,000-square-foot office complex that was once the Global Crossing headquarters in Los Angeles has been put on the market and it could end up as a hotel.

CBB currently represents a major telecommunications company that, surprisingly, is on the buy side, not the sell side. The company wants 400,000 square feet and has considered constructing its own building. Although corporate facilities were designed specifically for a particular company's needs, even with a redesign the premium to build is still 40 percent higher than acquiring an existing property, says David Binswanger, CBB president.

"Existing properties have hidden potential, but you have to do your due diligence because you are obviously buying someone else's idea of a perfect building," says Binswanger. As another alternative, a vacated structure could be a building owned by investors, as opposed to a tenant-user. There is a difference between the two. "The investors/landlords are always thinking about who the next user is going to be, so they structure the building to accommodate multiple potential users," explains Binswanger. "With a single tenant-user you are getting a building that was designed for just one purpose."

In either case, adds Hall, "if you are in the market looking for space there are definitely a lot of good opportunities." Studley's Schweitzer concurs. "There is tremendous opportunity for a tenant with growth needs or that has a lease expiring. It is a terrific time to be out there exploring ways to reduce rental expense and to potentially upgrade the quality of the working environment."

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