Building a Hollow Skyline

By Stephen Koepp

America's skylines once stood as stirring symbols of progress and prosperity. Yet in many cities the glass-and-steel monuments have now come to represent wretched excess. During the past five years, U.S. developers have constructed a breathtaking surplus of office towers, condominium complexes and hotels. In Los Angeles, a rusting, 17-story framework of steel girders on Wilshire Boulevard has stood idle for three years because of collapsed condo prices. Denver's tallest building, the 56-story Republic Plaza office tower, is only half rented despite such amenities as a concierge, an Italian-marble lobby, a car wash and computerized climate control. Florida's $197 million Le Pavillion hotel, part of a posh development called Miami Center, is usually only about 15% occupied.

Backed by eager investors and generous banks, developers failed to realize that they were collectively building too much. The amount of office space available and under construction in the 22 largest U.S. cities has reached 318 million sq. ft., or about as much as 150 Empire State Buildings. The glut has rocked the real estate business and the financial system by sending rents and property values plummeting. "We have overbuilt in this country on an unprecedented scale," says J. McDonald Williams, managing partner of Trammell Crow, the largest U.S. developer.

The most widespread surplus plagues the office-building market: more than 16% of total space is empty, compared with 3.5% in 1980. The vacancy rate continues to rise, in part because the building of offices is running 50% ahead of the growth in white-collar employment. Among the first cities to be hit by the glut were Denver and Houston, where demand for office space collapsed because of the downturn in the oil and gas industry. Hapless developers wound up with rows of "see-through buildings," thus named because they have so few occupants and interior fixtures. The developers of Houston's 34-story Phoenix Tower, who were unable to find any major tenants for the building, simply mothballed the structure to wait for better times.

The office-space surplus is rapidly spreading to other cities. Vacancy rates are reaching alarming levels in Fort Lauderdale (28.3%), Phoenix (24%), New Orleans (22.7%) and other Sunbelt cities, where the strong economic growth of recent years fanned real estate speculation. As soon as one city is glutted, developers move on to the next. Says Mack Taylor, an Atlanta developer: "When they realized the game was over in Denver and Houston, a lot of them came here."

The second shock to the real estate industry was the decline of the condominium market. Until only about a year ago, the U.S. was crazy for condos. More than 2.5 million units opened in a decade. But that produced a vast excess of supply, notably in California, Texas and Florida. Speculators who had bought condos in the hope of fast price appreciation saw the shakeout coming and dumped even more of them on the market. At the same time, demand was dampened by the maturing of baby boomers, many of whom now aspire to move from condos to split-level suburban homes with lawns. Many new condo projects, particularly luxury developments, have become virtual ghost towns. In March, Crocker National Bank repossessed a $28 million, 88-unit condo project in Glendale., Calif, because the builder had been able to sell only three apartments in two years.

The hotel industry, as well, has gone on a building binge that many innkeepers now regret. In Houston, the number of hotel rooms increased 46% between 1980 and 1985, to 33,530. Result: the city's hotels are only half full much of the time. Nationally, the room-occupancy rate has slumped from 71% in 1979 to about 65% currently. "There has been a tremendous number of hotels built in the last five years," says Linda Kalmar, president of the Denver Metropolitan Hotel Association. "It's intense. We're all very competitive, like the airlines."

The rivalry has pushed many hotels into the red. Houston's Warwick Post Oak, a 455-room luxury hotel built in 1982 for an estimated $70 million, foundered in March after three money-losing years. Metropolitan Life Insurance, a lender and investor, took possession of the hotel in a last-ditch attempt to save it.

The construction juggernaut is fueled by cash that flows abundantly from institutional investors, including pension funds, insurance companies, banks, and savings and loan associations. "Right now the money is very easy and very loose," says J.H. Snyder, a major Los Angeles developer. Since these investors traditionally have reaped large returns from real estate, many of them continue to pour money into it with the conviction that the market eventually has to improve. Says Arthur Mirante, president of Cushman & Wakefield, a large New York City broker: "The institutions have the staying power and a long-term mentality that borders on recklessness." In addition, many investors have been seduced by provisions in the federal tax code that can turn buildings into income shelters.

The go-go atmosphere is causing some nervousness in the financial industry. While giant insurance companies may be able to weather a slump or a mistake, savings and loan associations are generally not as strong. Following partial deregulation of their industry in 1982, many thrift institutions rushed into commercial real estate ventures before they were savvy enough to know the good from the bad. Says Kenneth Rosen, chairman of the University of California, Berkeley Center for Real Estate and Urban Economics: "Savings and loans should not be in this market unless they have high-level expertise. It's a very tricky market." So far this year, the Federal Government has bailed out three big California S and Ls that succumbed in large part to sour real estate loans. Beverly Hills Federal Savings (assets: $3 billion) collapsed in April, Southern California Savings of Beverly Hills ($1.5 billion) in June, and Bell Savings of San Mateo ($1.7 billion) in July.

Despite the glut, many developers keep on building as if they were bent on bankruptcy. Some of them plunge ahead because they believe their buildings are better than the rest. "It just seems to be a mania. Each developer thinks he's got a super-outstanding product," says John Amory, associate vice president of Coldwell Banker, a national brokerage firm. The builders of suburban Atlanta's Crown Pointe, which will contain 600,000 sq. ft. of office space in two buildings, believe that the project's swank restaurant, hotel and plaza will help lure tenants. "It gives us an aura," says Project Manager Kevin Moats. "Quality always has a way of leasing first, even in a soft market."

Many real estate firms are tempted to build and build because healthy companies can get loans with few questions asked. "The lender will look at the developer's financial statement instead of the feasibility of the project," says John McKnight, senior vice president of San Diego's Home Federal Savings.

Developers often make sound decisions that go wrong during the time span between groundbreaking and ribbon cutting. A builder may draw up plans when the market is favorable, only to find a surplus when the project is completed two to four years later. "At the time they make the commitment to go ahead, they may not realize how many other people are making the same decision. If one were not naturally an optimist, one would never choose to be a developer," says Robert Patterson, a Los Angeles-based managing partner of Laventhol & Horwath, an accounting and consulting firm.

For renters and buyers, the glut brings fire-sale bargains. Office-building owners offer concessions of as much as a year's free rent on a three-year lease. Condos, especially luxury models, are selling on the cheap. Goldrich & Kest, developers of the 64-unit Four Seasons complex in Beverly Hills, cut the price of a typical condo apartment from $750,000 to $500,000. "The building was an absolute knockout, but the market fell apart," says Warren Breslow, a general partner in the company. "We slashed prices and took a substantial loss."

Not all cities have surpluses of space. Chicago's office vacancy rate is a relatively low 13.7%, and in midtown Manhattan just 7.4% of the offices are empty. Only a decade ago, Manhattan suffered an office surplus that sent rents plummeting by 50% or more. But at the moment, New York's role as financial capital of the world is keeping space in demand despite a building boom. Manhattan's current construction totals 14.5 million sq. ft., more than is under way in downtown Los Angeles and Chicago combined. New York City's one area of weakness is its condo market, where sales and prices have leveled off.

In some cities, officials have begun to take action against overbuilding. San Francisco's board of supervisors, mourning the "Manhattanization" of their once quaint downtown, last month adopted rules that will sharply restrict the building of high-rises. The Boston Redevelopment Authority has offered a plan for limiting construction in the city's downtown, blaming development for creating canyon-like streets, blocking sunlight and overwhelming historical buildings.

Many real estate advisers are warning their clients against investing in office buildings, deluxe condos or other large-scale projects. But now is just about the time when the most freewheeling investors like to buy up the property that less daring owners are selling. Says Berkeley's Rosen: "A glutted market creates a lot of distress, but also great opportunities. The best time to buy is when the blood is in the street." He warns, though, that the bloodletting for developers and lenders will continue for at least another year. Says Jerry Speyer, managing director of the Tishman-Speyer office-development company: "Things will get worse before they get better." --By Stephen Koepp. Reported by David S. Jackson/Houston and Thomas McCarroll/New York

With reporting by Reported by David S. Jackson/Houston, Thomas McCarroll/New York