Gimme shelter

Gauging by recent venture capital investments, the hottest market in real estate is not pied-e-terres in Manhattan, low ranches in Marin County, Calif., or time shares in Cozumel, Mexico. The real money is in nondescript buildings close to the switching fabric of major transport providers. Those are the cozy confines that competitive local exchange carriers and other upstart service providers need to house routers, modem racks, switches and other equipment required to tap into next generation networks.

As incumbent carrier-controlled co-location spaces and central metropolitan area sites burst with tenants, providers are looking to an emerging class of outsourcers, called "neutral co-location" or "shared infrastructure" companies. By renting service providers physical space in buildings adjacent to fiber networks, these companies enable carriers to ramp up services quickly, with minimal capital outlays, while maximizing transport and interconnect options.

A less sexy business could not be found. "We literally walk the streets pulling up manhole covers," said James F. Lavin, founder and chief technology officer of Switch and Data Facilities. But venture capitalists value these young private outfits as if they're the next hot Internet infrastructure play.

Consider Colo.com, a 3-year-old, Brisbane, Calif.-based company led by Charles Skibo, former president and CEO of U.S. Sprint. Its third venture round in December 1999 brought in $200 million, led by Ameritech. The same month, Equinix, an operator of Internet business exchange facilities, raised $80 million in venture capital from the likes of America Online, Cisco Systems, Microsoft and Internet wunderkind Marc Andreessen.

To arrive at these large valuations, investors extrapolate from the explosion in e-commerce, said Laurie Gooding, a senior analyst at Cahners In-Stat Group. The increasing number of e-businesses and service provider applications, such as voice over IP and virtual private networks, are driving network traffic through the roof, she said.

Business models vary. For example, Equinix targets ISPs and application service providers, and Colo.com designs its facilities with a "carrier bent because carriers are the ones that need space everywhere," said Sean Dalton, general partner of Highland Capital Partners and an early investor in Colo.com.

"It's very much a McDonald's strategy - make everything look the same, taste the same, operate the same," he said. After the upfront investment, which can be heavy, these companies will be pure cash flow engines, Dalton said.

Colo.com competitor Switch and Data Facilities doesn't think it's that simple. "We have to sit - to the extent they exist - in the heart of the fiber networks," Lavin said of his company's "intense" location-driven strategy. "We think it is a problem if you have to get somebody to trench out a mile."

Measuring the market by sites already developed, Switch and Data is ahead, with 10 sites open in major citiesacross the U.S.

Although Switch and Data is adamant about not competing with its customers by selling network or transit services, its future may depend on the ability to branch out into enhanced services, Gooding said.

In addition, the cyclical nature of real estate coupled with the fast pace of broadband network buildouts could commoditize the market quickly.

"I am an old real estate guy, and I never underestimate the ability for these markets to get overbuilt," Lavin said.