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Corporate pendulum swings to urban office

Several decades ago, corporations looking to be close to the action located their offices in the downtowns of major metropolitan cities. But then came sprawl: The lure of the city's hustle and bustle gave way to an expanding population, as urbanites moved to the bedroom communities that sprouted up outside the nation's major metro areas.

As the suburban homemaking boom made commuting to the city problematic, businesses reacted by moving operations to the suburbs. The expected results were shorter commute times and less-expensive, more abundant land.

But the cycle seems to be making yet another turn. In the past few years, urban office has seen a renaissance of sorts, with downtown buildings wooing corporate users on the merits of infrastructure. Growing access to mass transit, cheaper rental rates and increased disdain for suburban traffic have all contributed to an increased desire for downtown office space. Further, general revitalization of downtowns across the nation has sparked interest in big and small businesses to scout for locations in the midst of a renewed downtown excitement and panache.

Efficiencies of urban space In Atlanta, a city known for its robust suburban market, BellSouth has set its sights back on downtown. The local telecommunications company recently reaffirmed its preference for downtown office space. Between 2001 and 2003, employees in approximately 75 leased and company-owned Atlanta-area properties will move to three newly constructed business centers located inside Atlanta's Interstate-285 perimeter.

Some buildings will be completed in 2001, with final construction set for completion by 2003. The three new business centers will house up to 13,000 of BellSouth's metro-Atlanta employees and have easy access to Metropolitan Atlanta Rapid Transit Authority (MARTA) stations.

"Our decision is grounded in quality-of-life issues for the Atlanta-metro region as a whole," says F. Duane Ackerman, BellSouth's chairman and chief executive officer. "With a number of leases due at roughly the same time, we have a great opportunity to take positive action in response to Atlanta's congestion and environmental challenges. Public transportation can and must be a powerful component in changing commuting habits. Also, by strategically grouping business units together, we'll operate more efficiently and our customers will be better served."

"This is a unique approach to corporate expansion," says Joe Chandler, BellSouth Telecommunications director of public relations, adding that BellSouth also plans to lease dedicated parking facilities at MARTA stations outside the perimeter for exclusive use by BellSouth employees to encourage use of the city's transit system. "All three sites are on or near the MARTA line, and the total square footage of the real estate is more than 3 million sq. ft. This is not an insignificant endeavor."

BellSouth based its decision to stay downtown on its existing presence in the city and the availability of mass transportation, Chandler explains. "When we examined our employees' demographics, we found that, by locating downtown, we were allowing half our employees to travel north to reach their office, and half would travel south," he says. "As we considered where our employees lived, and the traffic problems in the city, locating in close proximity to Atlanta's mass transit system became an obvious choice."

But most importantly, according to Chandler, BellSouth considered the decision as a reflection of its commitment to the city itself. "Atlanta is our headquarters," he says. "We wanted to make a commitment to the city, and a commitment to our robust downtown."

O.B. (Barney) Upton III, executive managing director of corporate services for San Francisco-based Cushman & Wakefield Inc., cites evidence supporting a renewed interest in downtown real estate markets. He says CBD vacancy rates nationwide dropped below suburban rates in 1998.

"Last year, the overall CBD vacancy rate was 10.8%, while in the suburbs it was 11.2%," says Upton. "And there certainly is more speculative construction in the suburbs than in CBDs, which will tend to hold the vacancy rates down in the suburban areas."

Ernest Johnson, executive vice president of corporate services for PM Realty Group, Houston, says lower-grade downtown real estate is available for the picking. "There is an abundant supply of C-grade buildings in the cities," he says, adding that these buildings may be an option for companies looking for a downtown location that are unable or unwilling to pay the higher rents usually found in an urban setting.

Johnson also notes the trend of corporations locating in out-of-the-way sites in order to benefit from lower land prices. "Some companies are now going toward second- and third-tier cities," he says. "The driving force in this movement is exit strategy - it's the number one consideration. In this business, we're always looking at what will happen if we need to unload the property."

Richard Smith, national director of corporate real estate for KPMG LLP, Washington, D.C., says many companies find the urban setting compelling due to its historic infrastructure and proximity to transportation. He adds that many universities are within downtown areas, which adds a built-in employee base for corporate recruiting purposes.

"Less mature industries usually can build a work force in the suburbs, though," Smith says. "That's why it's interesting to note that a less central location can work just as well for one company as the downtown location can for another."

Suburban market remains strong Despite the renewed interest in urban real estate, the business community has not yet dropped the suburbs from its list of expansion opportunities. On the contrary, both urban and suburban areas see substantial amounts of real estate growth, and some firms find it effective to maintain offices in both suburban and downtown locales in the same market. For example, according to Johnson, some companies choose to locate in the suburbs while maintaining a Class-A presence downtown.

"The biggest benefit to suburban office space usually is cost," says Johnson. "With all the mergers and acquisitions taking place in corporate America today, a primary consideration is the possible exit strategy in case a merger or acquisition affects a company's need for real estate."

Suburban space, he explains, is given up more easily. "Suburban real estate is an asset more easily disposed of," says Johnson. "The ground is usually cheaper in the suburbs, thus it has flexibility built in. Surface parking, for example, could easily convert to a parking garage, allowing the construction of another building on the property should an expansion necessitate it."

Dick Schaller, executive vice president of operations for Chicago-based CMD Realty Investors, says the big question that must be asked is, "Where do my employees live? These days, with unemployment at around 4%, it can be difficult to attract and retain skilled workers, so many companies are suburban bound where the employment base usually is greater."

Despite the city boom, the corporate real estate industry prefers the suburbs, he adds. "There is anecdotal evidence of a resurgence in the city. And there definitely are vibrant, exciting cities," he says. "But employers know that there generally is a preference among the working population for suburban areas."

There are exceptions, according to Schaller. "Denver, for example, has a vibrant, hopping downtown where businesses are vying to locate," he says. "It's an anomaly. Houston and Atlanta, for example, are seeing most of their growth outside the city. That's the way it's happening. We can't turn that tide. We, as a society, have fostered growth in a suburban pattern and companies continue to tap into that suburban employee base."

According to Johnson, the lack of mass transportation marks a significant downside to the suburban office.

"The suburbs are not served as well as the downtown areas," he says, noting that there may be more people in the suburbs from which to draw employees, so a location near a train line or bus route may not be necessary. Yet other industries, he says, find mass transit more important because of the high density of their work force.

Still, Johnson says a majority of his clients look to the suburbs for office space. "With the exception of financial services firms, we're seeing more interest in suburban locations than in the downtown areas," he says. "Historically, downtowns have fostered a home environment for financial services and the banking industry, but other than those uses, most of our clients are interested in what the suburbs have to offer."

Schaller also notes an increased commercial interest in the suburbs. "We've consciously invested in suburban real estate over urban real estate," he says. "That's not to say we're disinterested in downtown space, because we do own some downtown real estate, but we have refocused our energy on suburban space. That's where many of today's dynamic companies seem to be going."

Schaller adds that those companies choose suburban locations because of the access to and ability to maintain a quality work force. "Financial and legal operations continue to choose downtown locations because they have a historical presence there," he says. "But dynamic growth organizations more and more are using their own campuses in suburban locations where spill-over growth areas can be easily accessed."

Dynamics swing pendulum The pendulum will continue to swing between preferences for office space in the nation's downtown and preferences for suburban areas, according Upton. "I think we've seen a trend over the past few years away from the movement toward the suburbs, instead of back to the city," he says. "But the pendulum doesn't stop moving. There's always a trend one way or the other."

According to Smith, the benefits of downtown locations vs. suburban locations often come down to jurisdiction. "That issue brings all disciplines together to help make the decision," he explains. "The site selection decision should not be handled in an isolated way, but more strategically so all the pieces fit together. The key is the incentives provided by various sites."

These incentives, he adds, may be dwarfed by other costs that might be incurred, not in respect to any particular asset, but from a portfolio viewpoint. "Companies have assets that they own, there are those they lease, and those that are part real estate, part something else," says Smith. "That is why this is an industry where a variety of people may be involved in corporate site selection. There is a broad array of concerns, such as taxes and assurance."

Smith also says that, when selecting a site, a determination must be made as to whether it is to be purchased or leased. "That decision is usually driven by what is available in different marketplaces. It's often too expensive to own property downtown, though it may be cheaper to lease there. On the other hand, it could be an asset to own real estate in the suburbs."

Smith says the high-tech industry, for example, prefers suburban locations because they can use the added room to spread out. "Connectivity to the city usually is not crucial for high-tech companies," he says. "Conversely, some industries need more centralized locations due to the nature of their business. And the advantages to an urban setting are overwhelming."

Upton cites examples where major high-tech corporations favor returning to downtowns. In San Francisco, companies such as Sega, U.S. Web and CKS Software all have moved from the suburbs and Silicon Valley into San Francisco. In Dallas, CNA has moved downtown, while in Houston, Continental Airlines has gone urban. In Detroit, CompuWare has moved to the city as well.

"Back in the 1980s, the trend was to move from the cities to the suburbs," explains Upton, adding that the conditions at the time dictated the change. "It was a cost- and convenience-driven move. Now there's a certain cache to being downtown and an excitement about the city [that wasn't there before]."

From a cost standpoint, it was less expensive to do business in suburban areas, and it reduced commutes for employees living in the outlying areas. "But then suburban rents began to increase, and vacancy rates decreased," says Upton. "Cost differentials began leveling out. And other factors came into play. In the early-1990s, we saw a lot of downsizing of corporate America. With fewer people, there was less cost differential, and cities allowed corporations to be closer to their financial centers, consultants and other amenities. That swung the vote in the other direction."

And, depending on the business type, presence in the city can be crucial, Upton says. "We've seen a huge emergence here in San Francisco. We call it the multimedia gulch - an enormous relocation of multimedia companies to the city for the purpose of tying into the city infrastructure. To gain better access to satellite facilities, cable and other electronic infrastructure, multimedia companies find downtown settings the best choice."

Industry experts agree that urban office space has come back into the spotlight - but not at the expense of its suburban counterpart. Last year saw nationwide CBD rents rise about 13%, compared with just 8% in the suburbs, so cost dynamics seem to be swinging again. "There is a more significant benefit to moving back to the suburbs right now based on these figures," Upton says. "It will be interesting to watch these dynamics continue to swing the pendulum."

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