HQ Global is in Chapter 11 and Regus has restructured in the US. We explore the disparate and troubled US serviced office market
For serviced office operators in the United states, the American dream has turned into a nightmare. Regus has confirmed its US operation lost £9.7m in the quarter ending 31 March 2002. It may have avoided filing for bankruptcy, but its biggest competitor, HQ Global, is engaged in Chapter 11 negotiations after its programme of acquisitions in the late 1990s led to a bizarre situation where the company became its own biggest competitor.
On one intersection in Phoenix, Arizona, the company had a HQ centre on all four corners. But this is just one incident from HQ’s catalogue of woes. With debts believed to be in the region of $100m (£68.2m), the company has closed 50 centres in the US, nine in continental Europe, and has revealed to Property Week that it plans to shut 10 more.
Although it is business as usual at HQ’s remaining 278 US centres, negotiations with creditors are ongoing. A debt-for-equity swap seems the most likely solution, but can HQ really convince backers it can return to its former strength? Heading the salvage operation is HQ’s American CEO, Jon Halpern. He concedes the company’s massive expansion programme ‘lost sight of some of the details’, but maintains that despite its troubles, HQ will remain market leader. ‘We are not a casualty,’ he insists. ‘We are the first to take our medicine, and we are the first survivor.’
Describing the bankruptcy filing as ‘the closing of the procedure, not the start’, Halpern believes HQ’s long-term future is assured. ‘Chapter 11 is a process designed to give a company breathing room to digest what in our case was an overindulgence,’ he explains. ‘We were caught in an exciting economy, and grew faster than we should have.’ Halpern reports that under the new arrangement, HQ has $20m (£13.6m) cash, and has not dipped into a $30m (£20.5m) credit facility arranged with its creditors.
These creditors have been patient. David Harris, an independent analyst at Lehman Brothers’ New York office, feels their patience will be tested again. ‘Equity Office Property, a quoted REIT, is the biggest office owner in America – the US equivalent of Land Securities,’ he says. ‘It is backer of HQ Global, and has an ongoing JV with Regus. However, there are a number of problems with regard to HQ Global.’
According to Harris, EOP wrote off $124m (£84.6m) in impairment charges at the end of 2001. ‘Technology write-offs were $33m (£22.5m), but $91m (£62.1m) directly related to HQ,’ he said, adding that this represented the entire value of EOP’s investment in the company. EOP’s annual report, released in April 2002, revealed that as of 31 December 2001, HQ Global occupied about 74,320 sq m (800,000 sq ft) in the REIT’s office portfolio.
The report places annual rent for this space in 2002 at a further $22m (£15m).
Unfavourable lease terms are the biggest problem. HQ’s rapid expansion programme coincided with the dotcom boom. ‘A number of the office suite companies have leases where landlords are charging a premium rent, significantly above market rates,’ confirms Harris.
The drop in US office occupancy rates has compounded the problem. ‘In the US, normalised occupancy is around 94%-95%,’ says Harris.
‘The figures from EOP put occupancy at 90%.’
This glut of space and growth of the sublettings market means tenants have more choice, landing serviced office providers like HQ in a no-win situation.
This is the medicine HQ had to swallow. In its heyday, HQ’s occupancy figures were as high as 89.9%. By September 2001, they stood at 71.3%, and Halpern admits that at present they are ‘somewhere shy of 70%’. Six months before the Chapter 11 was filed in March 2002, efforts were being made to remedy the damage. HQ’s creditors gave forbearance on all of its debt, leaving the company in a position to restructure in an attempt to reduce costs.
We are the first to take our medicine, and we are the first survivor
Jon halpern, HQ Global
‘We rationalised our inventory and made sure we were in markets that made sense,’ Halpern said. ‘We lined up new financing and have closed redundant centres and those not in core markets.’
HQ pulled out of nine centres in Europe – including centres in Germany, Spain, Austria and the Netherlands – as it felt strategic links with the US were low. ‘Of the 1,500 workstations we had in continental Europe, only 20 were related to US clients,’ says Halpern. ‘By contrast, of the 4,400 workstations we have in the UK, 1,200 are related to US clients. As a platform for US companies to do business in Europe, the UK will become stronger.’
Fine-tuning
Halpern admits that more centres in the US will have to close. ‘We’ve got a little bit of fine-tuning left to do,’ he says. ‘In terms of future closures, we’re talking 10 right now where markets are weak.’
He believes that HQ has faced up to its problems in time, but fears the less-than-forgiving market conditions will continue to plague the sector.
‘There are going to be casualties,’ he warns.
Halpern rules out any possibility of restarting merger talks with Regus. ‘There would be no reason to do so,’ he asserts. Certainly, Regus is not of mind to view HQ as a significant competitor.
‘We don’t have significant business service operator competition in the US,’ said a spokesman for Regus. ‘Out of every 400 deals, there are 399 where we are pitching against conventional space or sublets.’ HQ’s programme of closures has led Regus to see some stabilisation in prices. Even so, Regus admits the US has been a problematic venture. ‘The US market has been tough, it is still tough, and it will continue to be tough,’ the spokesman added.
But Harris has faith in Regus’s future. ‘Regus is well placed compared to HQ. The US market has seen a severe downturn, but Regus has a more global footprint,’ he says. Even so, Harris points out the serviced office sector ‘has not generated the kind of growth people were expecting a few years ago’.
The issue of HQ’s $100m (£68.2m) debts will be thrashed out over the next six months as the Chapter 11 negotiations continue. ‘There are various options of what to do with our old debt,’ says Halpern. Although he does not rule out the option of the company being recapitalised, he confirms: ‘Debt being converted to equity is the more likely route, but it’s down to the investors and creditors to work out who owns the company. Creditors tend to step up and take ownership in these situations. Probably that’s what will happen with HQ.’
As for future, Halpern believes franchising is the key to any future growth. One-time CEO PJ Tyson has been appointed to re-establish HQ’s operations through franchise relations.’HQ will return to the capital cities of Europe, but with strong local partners,’ asserts Halpern. Business in the US will also be expanded, but more cautiously than before.
‘There are areas where HQ should be represented, but in partnership with a local, hands-on entrepreneurial franchisee,’ says Halpern.
US market overview
The serviced office concept first emerged in America in the 1970s. US regulator Office Business Center Association International (OBCAI) estimates that of the 5,500 serviced office facilities worldwide, 4,000 are in North America. It considers the US market to be worth £3bn annually. Most of the industry consists of ‘mom and pop’ operators – small, family-run centres. These are typically located over one or two floors in a large office building, providing break-out space for existing occupiers, and temporary space for home-based businesses in the vicinity. By contrast, firms such as Regus, which chase corporate outsourcing business, are in the minority. However, the quality of service and facilities provided are greatly superior. In the UK, the market is younger, but far more focused towards corporates. UK researcher Actium Consult calculates the industry has an annual worth of £900m with 1,000 serviced offices across the UK. In a reversal of the US situation, the researcher estimates 80% of these serve the premium sector.
