Adrian at the Scrum Development message group handed out a list of resources for justifying co-location of teams. It covers international and intra-building co-location.
Your instincts tell you that this model is right. Broader bands of communication help get things done.
People working close to each other over-hear conversations and chip in with their experiences and opinions.
Us and Them divides are conquered.
One space per team...
The list is good. Check it out.