The Great Office Giveaway

By Richard Behar.

You can say this for the country's real estate promoters: even in the worst of times they are unsinkably optimistic. Yodels Jerry Lumsden, a property broker in Austin whose 27% office vacancy rate is among the highest in Texas: "The trend line is good." The Lone Star State, like the rest of America, is reeling from what many experts consider the most glutted commercial real estate market since the 1930s. The culprit: the 1980s, of course, during which U.S. office space doubled, to 5.38 billion sq. ft. In city after city the industry is overleveraged, overbuilt and underleased. At 540 million sq. ft., the unrented space across the country equals the total space available in 10 Bostons. That translates into an annual industry loss of $65 billion in lost property values. Downtown vacancy rates are at a record high 17% nationally, twice their historic levels.

Some cities are virtual disaster areas. San Bernardino, glut capital of America, has a commercial vacancy rate of 33%. Next come New Haven (30%) and Springfield, Mass., and New Orleans (both 28%). Even in posh Beverly Hills, the rate is so high (25%) that city officials journeyed to the Orient in January to try to woo prospective tenants. Bucking the trend are a few lucky cities, most of them sleepy state capitals that hotshot dealmakers bypassed in the '80s. Among them: Lansing, Mich. (10%), Albany (9.6%), Raleigh, N.C. (9.4%) and Sacramento (6.7%).

The office glut is in some ways just another broken leg of the savings and loan crisis. Many thrifts went bust by tossing money into high-rises that never should have been built in the first place. As a result, few analysts expect a rebound soon. In the suburbs of Chicago, a virtual shutdown of new construction since 1989 has failed to budge the vacancy rate, now between 15% and 20%. "When will lenders lend again?" wonders Hugh Kelly, an economist and real estate consultant. "For some major markets, vacancy rates will have to fall well below 10% before the money spigots get turned back on."

Of course, one man's glut is another man's glee. Office renters everywhere are demanding and getting deep discounts, huge renovation allowances and better services. In Manhattan, where the rate of empties is 14%, some renters receive a full year rent-free plus a one-time allowance of $60 to $100 per sq. ft. for improvements. In Boston (16%), one of the city's largest law firms, Hale and Dorr, has been threatening for months to move to new quarters. Last week the nervous landlord persuaded the company to stay put at $20 per sq. ft. -- 40% less than the rent Hale paid in 1989. "It's the worst overbuilding in my 22 years in the business," complains Richard Reynolds, a Boston developer.

A few markets, such as Houston, got overbuilt so many years ago that demand is finally catching up with supply. An 18-story office building owned by Exxon's real estate subsidiary is rising from the ashes of the city's north side -- the first major new commercial structure in five years -- and it is already mostly rented. Other skyscrapers, long mothballed, report 70% to 90% occupancy, evidence that the economy is reviving, diversifying and depending less on swings in oil prices. But Houston's vacancy rate is still a painful 25%, with even heavier vacancies in lower-quality buildings.

Much of America's excess office space is in the hands of federal caretakers -- hundreds of office buildings and luxurious high-rises built by starry-eyed developers whose failures wiped out their S&L lenders. Just when the feds don't need it, a new small-is-good trend may make unloading those glass- sheathed monsters even harder. "Plush offices are out," insists Dallas broker Wayne Swearingen. "It's not in vogue to show how rich you are." Or were.

With reporting by William McWhirter/Chicago and Richard Woodbury/Houston