Wired buildings bring high speed added value

The UK property industry has learned a new mantra; broadband, broadband, broadband. It would be hard to say it has superseded its historic predecessor, location, but the speed with which the industry has rushed to embrace the concept of wired buildings is breathtaking. From an industry that barely understood the needs of its customers as recently as a year ago, it now says it needs to serve its customers better. And what better way to serve them than with a product that not only enhances the value of the property but also gives the landlord extra income?

A consortium of some of the UK's largest property owners - advised by investment bank Morgan Stanley Dean Witter - this week selected a preferred provider to wire up its buildings for high-speed broadband capability. The company, HighSpeed Office, will be owned by the specialist investment bank ARC, Marconi and the landlords.

HSO aims to negotiate with a provider of telecommunications services for bulk purchase of telephony and data transmission services, which will then be sold on to the landlords' tenants. HSO's shareholders will pocket the difference between the price charged for bulk purchases of telephony services and the price charged to tenants, less costs.

HSO thus joins Centric, a Goldman Sachs-backed company that has begun to wire up UK office buildings. But compared with their US counterparts, UK property owners are laggards in discovering the opportunities from uniting technology with property. Indeed, it may be argued, the UK has come so late to the concept that, looking across the Atlantic, it has already missed the boat.

So-called building-centric telecoms companies on the model of HSO have been stock market darlings in the US since late 1999. Landlords, mostly publicly quoted property investment trusts, have been investors in and lenders to these companies, and they have made much of the potential value these can add to their share prices. However, all that stopped in the third quarter of last year when shares of building-centric telecoms providers plummeted.

Shares in one-time star, Allied Riser Communications, stood at $3 on Wednesday against a 52-week high of $48.75. Cypress Communications, this week at $1.06, was $29.94 last year. Lee Schalop, e-real estate securities analyst at Bank of America, says the problem is that building-centric providers are hard hit by the capital crunch facing high-technology start-ups. Their expansion plans have incorporated cash-burn rates that require repeated injections of capital. Now that fresh capital has disappeared, the roll-out of further installations is grinding to a halt.

Allied Riser announced in October that it had shed 115 employees. FrontLine Capital Group also revealed in October that for nine months it had not paid interest on loans outstanding from Reckson Associates, the company that spun it off. It announced it would lay off 75 per cent of its workforce and slow growth. Indeed, Mr Schalop says, the risk is not only that tenants may not gain access to new high-speed broadband services, but that services to existing tenants could be halted.

Mr Schalop is not alone in that view. John Lutzius, analyst at Green Street Advisors, a California-based real estate securities research firm, says landlords have taken big risks through stakes in building-centric telecoms operators. "If these companies go under, you have a good chance of service interruption until there is a recapitalisation. That could be several months," Mr Lutzius says. "Landlords have to deal with the consequences of allowing a third party to control the building infrastructure."

Landlords might be forced to make investments on a scale they never imagined just to keep tenants happy. Chris Butchers, chief executive at HSO, says the collapse of the US-based building-centric providers has offered his company a guide to mistakes that are avoidable. He says HSO can avoid the worst by moderating its pace of expansion, although he acknowledges the dangers.

HSO requires £20m sterling in capital to finance the launch of the product over two to three years and the investors have not yet decided how that will be split between landlords and other shareholders including Marconi. "We have to sit down with the owners and see how fast and furious they want to wire up their buildings," he says.

That pace could be slower than that of the US. For one thing, the most attractive buildings from HSO's point of view are multi-let to a variety of small to medium-sized enterprises that want access to high-speed telephony but cannot afford to install it.

Because UK landlords favoured single-let premises, it is not clear how much of the 40m sq ft owned by the consortium is worth wiring in the early phase. Mr Lutzius says it has never been clear to Green Street whether investments in companies such as Allied Riser will ever add much value to property companies. "Landlords were being a bit cute by saying they are acting in their tenants' interest while trying to cut the best deal for themselves," he says.

Mr Schalop says that one possible solution in the new, capital constrained market is for landlords to face up to the fact that it is in their commercial interests to wire up their own buildings, and perhaps they should just dig into their own pockets. Wired buildings command higher rents and eventually, unwired buildings may command no rent at all, he says.

Mr Schalop quotes Gerry Lederer, author and lawyer for the Building Owners and Managers Association, on the subject: "In the future, there will be no `smart' buildings, just `dumb' buildings. And they'll be easy to identify - they'll be empty."