‘See-Through’ Interiors : Office Glut: It Sweeps the Country
Not far from Houston’s central business district stands the glistening new 34-story Phoenix Tower. Thirty-three of those floors are empty.
Behind the building’s skin of blue-green glass is an interior that is decorated only with naked wiring and bare metal--huge, empty spaces that are hot and dusty with grit from unfinished cement floors. Although the tower was completed last year, its only occupied part is a small 11th-floor office used by building management as the search goes on for a client big enough to open the building.
Finding such a client is an unlikely prospect at the moment. This is a city of “see-through” buildings with no interior walls to block one’s view of the under-used structure next door. Houston has more than 37 million square feet of vacant office space--twice the footage of all the commercial buildings in Kansas City.
New Office Construction
Between 1980 and 1984, 471 office buildings were completed here. Construction has now slowed considerably, but across America, real estate and investment experts say, dozens of other cities appear to be new Houstons in the making.
Unlike past boom-and-bust cycles in office construction, today’s surge in building has not been significantly moderated by the lack of demand for additional space. Instead, billions of dollars in investment money looking for a place to alight are creating a forest of lonely high-rises.
The Office Network Inc., which tracks the commercial market in 22 cities, estimates that 318.4 million square feet of office space is either available now or under construction in those 22 cities. That figure is roughly equal to the total office space in Denver, Atlanta, Boston, Miami, Philadelphia, Pittsburgh and Cleveland. Put another way, it is the rough equivalent of 150 Empire State Buildings, each with 2.1 million square feet of rentable space.
‘Country Is Overbuilt’
“The entire country is overbuilt,” said Kenneth Sandstad, vice president and general manager for Coldwell Banker Commercial Real Estate in Dallas. David Shulman, the vice president and director of research planning for the Los Angeles-based TCW Realty Advisors, said: “In terms of square footage, it’s probably the highest in human history.”
The result is that investments that looked very good two years ago now appear very shaky. Many investors, including some savings and loan associations that plunged heavily into construction financing, may be on the verge of hard times, according to industry analysts.
Several factors contributed to the open-ended funneling of bil lions into commercial real estate:
--Booming Sun Belt cities like Houston made a need for new construction obvious, and sometimes the enthusiasm lasted longer than the need or carried over to cities where the need was less compelling.
--Federal tax incentives passed in 1981 offered investors advantages even if the buildings they financed were under-used, and, for many, such tax shelters seemed too good to pass up.
--Deregulation of savings and loan institutions in 1982 gave added impetus to the boom by allowing such institutions to steer away from their historical role as makers of home loans and into commercial real estate ventures that looked more profitable--but were also more risky.
--Foreign investors, and particularly those in oil-producing nations--found American real estate investments less hazardous than other investments here and abroad.
--The traditional investors in commercial real estate--huge corporations, banks, pension funds and insurance companies--all envisioned good profits and stayed in the market with a vengeance.
Beginning of Boom
Virtually all real estate experts and developers agree that the present building boom began in the late ‘70s, when there was an undersupply of office space. Developers cranked up to fill the void, but in many cases, the building continued right through the recession of the early ‘80s.
One important spur to investment came with the new tax law of 1981, which allowed developers and investors to accelerate their depreciation on projects to 15 years from 30 years. In other words, the costs of an entire project--exclusive of land costs--could be deducted from taxable income in 15 years, making it a major shelter from income taxes. That number was later raised to 18 years and President Reagan’s new tax package would increase it to an even less favorable 28 years.
The law, when passed, was intended to spur growth, but now the Reagan Administration is intent on recouping some of the tax money lost from large write-offs.
Incentives to Overbuild
“Yesterday’s incentive--today’s loophole,” said one Washington economist.
Barton Smith, the director of the Center for Public Policy at the University of Houston, agreed.
“I think right now there are federal tax incentives to overbuild, and that is a national problem,” he said.
Bob McIntyre, the director of federal tax policy for the Citizens for Tax Justice--a labor-supported tax reform group--said he believes the tax incentives are the sole reason for the glut of construction.
“Everyone I know thinks it was the tax incentives, first, last and always.” he said. “The resources that went into that could have gone into something else.”
High-Yield Investments
But others point out that savings and loans have added new fuel to the fire. They became a factor in the market after they were deregulated in 1982. Since then, savings and loans have moved away from home loans and into commercial building in a big way, seeking high-yield investments that would allow them to pay competitive, higher interest rates.
However, with the promise of higher yields have come higher risks, and some ill-advised investments. A notable example is the Beverly Hills Savings & Loan Assn., which was taken over by federal regulators who found its condition unsafe partly as a result of a number of sour real estate investments. One Houston economist, who asked not to be identified, went so far as to say that savings and loan institutions had been involved in “crapshooting.”
Thrift industry analyst Jonathan E. Gray of the New York securities firm of Sanford C. Bernstein & Co., said S&Ls; will probably make more money this year than in any year in their history because lower interest rates are reducing their pay-out to depositors. But he also warned that a number of associations hold large portfolios of real estate that are earning very little.
Gasping Last Breaths
He said his guess is that about 10% of the country’s 3,600 savings and loan associations “are gasping their last breaths.”
Identifying S&Ls; that are about to go under because of bad real estate investments is unwise, because as one economist put it, “doing that would be a self-fulfilling prophecy. You mention an S&L; and there would immediately be a run.” But others do speak in general terms about the concern in the real estate industry.
“It’s a disaster,” said one real estate expert who asked not to be identified. “I think that if the S&Ls; had to declare how much land development they are financing, it would be very scary. I have the distinct impression that many banks belong in the same boat.”
Bank Failures Cited
S&Ls; and banks are now under much closer scrutiny by federal and state agencies as a result of a number of failures in recent years. But real estate analysts say it was not unusual in 1982, when the buildings coming on line today were being planned, for financial institutions put up all of the money for a project, leaving the developers with no risk to bear. While that meant more money would be made if the project was a success, it also meant the financial institutions would be left holding the bag if it was not.
One of the best-known cases of that sort involved Empire Savings & Loan in Dallas, which pumped $400 million into condominium projects before it went bankrupt and was taken over by the Federal Savings and Loan Insurance Corp.
Ed Cappel, vice president and resident manager of Coldwell Banker in Houston, said one cannot fault the developers for wanting to put up more buildings. “They are in the business of building buildings,” he pointed out.
Cappel said he was more worried about those offering to bear the entire cost.
‘No Risk at All’
“Hey, I don’t feel good about that,” he said. “I don’t want S&Ls; out there making tremendous capital investments, when those developers have no risk at all in the deal.”
Dall Bennewitz, director of mortgage investments for the U.S. League of Savings Institutions, one of the largest trade associations in the industry, said he does not believe the fallout on commercial investments will be as dire as some predict, but he did say he knew of S&Ls; around the country that wished they had not made office project investments they must now live with. He said institutions were still making such investments, but on a much more selective basis.
“You would have to have a hell of a package to sell it,” he said.
Cappel and others see a shakeout ahead. He said he could envision a number of foreclosures on office buildings in the coming two years.
Construction in Dallas
For example, Dallas now has 121 buildings under construction, which will mean 25 million square feet of new office space. Another 117 are on the drawing boards. Coldwell Banker’s Sandstad recently delivered a talk to the real estate department of Republic National Bank, in which he contended that building was breaking all the financial rules, and that overbuilding had become “chronic” because of the availability of capital.
“The market is in for tough times,” he warned.
In Denver, where the office vacancy rate hovers at about 25%, one of the highest in the country, construction nevertheless continues, with 3.5 million square feet of office space going up in the booming southeast section of the city alone.
Inducements to Tenants
To attract tenants, landlords are offering huge inducements. The 56-story Republic Plaza is one of the most prestigious new addresses in the city, complete with concierge, car wash and a lobby finished in elegant Vermont marble. But to lure one tenant, the leasing agents gave the company two years’ free rent on a six-year contract, along with a generous allocation to put the finishing touches on 1,700 square feet of space.
In Oklahoma City--like Denver and Houston, a community set on a fast track during the energy boom and now slowed by the energy downturn--one development, the 713,708 square-foot Leadership Square, has filled only a fourth of its space since it opened a year ago.
But overbuilding is not just indigenous to cities dependent on the energy market. In Phoenix, which caters largely to high-tech industry, landlords are already having to make concessions to tenants, while 4.8 million square feet of additional office space is going up. That figure almost equals the amount of vacant office space now available in the city, and of the space under construction, only 719,450 square feet has been pre-leased.
‘Let’s Go to Phoenix’
“They just keep building,” said John Amory, an associate vice president with the Phoenix office of Coldwell Banker. “The developers who used to build in Houston and Denver are saying, ‘Let’s go to Phoenix.’ ”
In San Diego, Dallas, Atlanta, Miami and Los Angeles (4 million square feet of premium office space is expected to hit the market in Los Angeles this year and next), the responses are similar. The United States, with the exception of the major cities in the Northeast, is being overbuilt. And those Northeastern cities, some real estate experts contend, defy the trend only because strict municipal building codes and the amount of time it takes to put together a land package make construction more difficult there.
Chicago has one of the lowest vacancy rates in the Midwest, but “things are going to change dramatically for the worse,” said Richard Kateley, a senior vice president at Real Estate Research Corp., a Chicago-based national real estate investment consulting firm. “There are a large number of new buildings on line that will be ready for 1986, ’87 and ’88 and there’s almost 10 million square feet of office space under construction right now.
Vacancies Forecast
“We’re forecasting that in two years from now the downtown area will be 14% vacant while the suburban areas will be seeing 25% to 30% vacancy rates,” he said.
Real estate experts believe that a healthy vacancy rate is about 7%--enough to allow for movement within a city. Today, the downtown office vacancy rate nationally is about 15% and suburban vacancies are almost 19%.
Ron Witten, the president of Dallas-based M-PF Research, which specializes in locating choice sites for commercial development, contends that it is still possible to find sites that can be developed for a profitable office building. But Richard Everett of Houston-based Century Development Corp.--a major developer in the city--said his company spent two years looking nationwide for a spot to develop a major project, but to no avail.
“I couldn’t name a city today that has a strong market,” he said. “I can show you dozens of future Houstons.”
Shulman, of TCW in Los Angeles, agreed. “There are no places where they are underbuilding. It’s going to get worse for at least another year. We’re going to have high vacancies for at least another five years. And you have to remember that the good part of the (nationwide economic) recovery is behind us.”
