Downtown Sits on the Brink of High-Rise Building Binge
On paper, downtown San Diego is on the brink of another high-rise building binge reminiscent of the early 1980s, when it seemed that a new skyscraper was rising on every corner.
When it ended, downtown woke up to a glut of office space, a hangover from which it is only now recovering.
Today, as record-high 26% vacancy rates gradually inch downward--they’re expected to reach 12% by the end of the year--no fewer than five major high-rise office projects, with a combined 2.2 million square feet, are jockeying for position.
To an industry that has often defied the economic logic of supply and demand and is prone to cycles of frenzied pack activity, the question seems to be whether San Diego can expect a rerun of 1982-84, when five large high-rises--four of them in 1982 alone--were opened. Their immensity, about 2.5 million square feet, nearly doubled the floor space of all the major office structures built downtown in the previous 11 years.
It’s highly unlikely, say several developers, leasing agents and government officials, that the impending second wave of projects will hit at the same time. But, they note, it’s also not an impossibility.
There exists, for example, the combination of low interest rates with competitive companies and entrepreneurs aggressively pushing their projects that could cause as many as three or four high-rises to open within a year or two of each other.
The biggest obstacle to an early-’80s replay, however, is the lesson of overbuilding, learned in downtown San Diego and in cities across the nation.
More than steel and concrete, the foundation for high-rises rests on the banks, insurance companies, savings and loans and other large lenders who provide the money to make buildings go.
Many of these lenders have seen their profits disappear in empty offices and, as a result, have become much more cautious about approving loans. The most dramatic change between the building boom of the early 1980s and today, according to developers, is that lenders are requiring substantially more preleasing in a project as proof of an existing market.
The clearest evidence of that is the $143.5-million Symphony Towers office and hotel complex that will begin construction this week. The downtown project, on a block bounded by A and B streets and 7th and 8th avenues, is nearly a third leased, even though it won’t be finished until autumn, 1988.
“The key now is you got to get the preleasing,” said John Whitney, one of three managing partners in Charlton Raynd Development Co., the developer of Symphony Towers. “It’s not just San Diego, but all over the country . . . projects are being looked at much, much closer and more stringent than in 1982. The experience of the early 1980s has put all lenders and developers on notice.”
There also is another limiting factor working in San Diego, Whitney said.
“You will see one or two additional buildings come up (starting in late 1988), but I certainly hope, and I would doubt, that you’ll see the kind of wave coming that happened in ‘82,” he said. “Some of the same players are still involved and they are sensitive to” the dangers of overbuilding.
Some of those same players are the Koll Co. and Trammell Crow Co., whose buildings contributed to the early 1980s office glut. Both have announced plans for new office high-rises.
That earlier downtown building binge was based largely on the center city’s hunger for high-rises. Between 1976 and 1982, not one major office building was constructed downtown, sending the vacancy rate plummeting to almost nothing.
“That’s why all the developers got excited. The trouble was they all got excited at the same time. You ended up with five years’ worth of buildings in one year,” said Dennis Hearst, office leasing specialist for the real estate firm of Grubb & Ellis. “Things could change in the next five years, but today, I think it’s maybe impossible to get a project going unless you have it 25% to 35% preleased. Lenders, in order to avoid what happened in the past, have just demanded more. So I think you’ll see them built as they are needed.”
Under that scenario, downtown, which has an annual office absorption rate of about 400,000 to 600,000 square feet, would plod along with one new high-rise a year into the early 1990s.
In agreement with the new demand-and-supply theory is Gary Toeller, a Los Angeles-based western regional vice president for Cabot, Cabot & Forbes, a development company that wants to build a 19-story, 360,000-square-foot building at Columbia and C streets.
“The environment has changed because financial institutions want at least 30% preleased, unless there are high guarantees, meaning developers taking more of the risk,” Toeller said. “That’s our philosophy (getting tenants to prelease space) before we’ll move ahead.”
As a result, Toeller said, “everyone is moving cautiously. People want to hit that window (of opportunity) in the next two or three years.”
What nobody wants, he said, “is a blood bath again.”
So far, Cabot, Cabot & Forbes has not signed a tenant for its building. “We would have liked to have been in the market by mid-1988,” he said, “but now we’re looking at the first quarter of 1989.”
Another developer that has clearly felt the impact of San Diego’s overbuilt market is Manufacturers Life Insurance Co. The company has pulled back on its plans to build a 22-story, $60-million office tower at 2nd Avenue and Ash Street.
“It’s kind of on hold right now,” said Rob Schaefer, manager of the company’s San Diego real estate office. The company, which also has had trouble lining up tenants, is reevaluating its concept. Instead of a single high-rise, Schaefer said, the firm is looking at the possibility of constructing a handful of smaller buildings in a phased development.
Still, there are those who say that when it comes to high-rise office construction, even in the face of these self-imposed restrictions, the industry is such a volatile creature that San Diego could well experience another spasmodic expansion.
While some of the changes in the industry, especially on the part of lenders, are real, “don’t expect it to become rational,” said Sanford Goodkin, chairman of the Goodkin Group, a San Diego-based real estate research and consulting firm.
“A glut is more normal than an unglut is abnormal,” Goodkin said. “If you give builders enough money, they will cover the world with empty office buildings. It’s pretty much of a three-year cycle, where everyone gets crazy at once.
“The point is there is no supply and demand as far as building offices anywhere.”
Goodkin believes one of the “fundamental differences happening in real estate” is what he calls the “deep pockets” syndrome, a phenomenon common in Europe in which investors and financial institutions base their financing on long-term returns, rather than the two- to three-year turnaround to profitability that American lenders usually require.
“It’s where someone doesn’t expect to turn a profit the first or second year (after a building is opened) but in 10 years,” Goodkin said. “The basis for investing is whether the building is in the right town and the right place in town . . . with a strong likelihood of a healthy return in the long run.”
In this regard, Goodkin said, San Diego is an attractive market.
It has a new downtown environment different from the early 1980s, with the opening of Horton Plaza, the U.S. Grant Hotel, the pending construction of the convention center, a growing downtown residential population and an expanding regional economy.
An example of what Goodkin is talking about is the proposed $115-million Shapery-Emerald Center, a twin-tower office and hotel complex at Broadway and Columbia Street. Sandor Shapery, a San Diego developer who is a partner in the project along with Emerald Management Co. of Hawaii, a subsidiary of the Japanese conglomerate Tokyu Group, said he is not looking to prelease tenants for his 30-story, 375,000-square-foot building.
“We’re looking at this for the long term. With the people I’m dealing with, they are much more long-range-looking,” Shapery said. Emerald company officials have talked about seeking locations for development that promise to be profitable in 10 years.
“Preleasing is not crucial for us,” Shapery said. “The problem is that you make such major concessions (in order to attract tenants) that in the first couple of years it has an adverse impact on the project. And the larger the tenant, the larger the concessions.”
Shapery said his partnership is seeking the $100 million necessary to finance the project from a consortium of American-based Japanese banks. Ironically, it’s Shapery’s belief that San Diego now stands to benefit from the building boom of the early 1980s.
“The best thing that happened to San Diego . . . was 1982. We were the first to be hit (with overbuilding) and now we’re getting out of it,” Shapery said. “All of the projects people are talking about are based on that assumption. I think it’s going to be a repeat (of the early ‘80s).”
More skeptical about what might happen is Gerald Trimble, executive director of Centre City Development Corp., the city’s downtown redevelopment agency, which is involved in assembling land in both the Shapery project and the Koll development, a $200-million project also on Broadway that will include offices, a high-rise hotel and apartments.
“Everyone says they plan on starting next year, but wait to see what really happens,” Trimble said. “Developers want to go forward but the lenders are saying, ‘Wait a minute.’ ”
In addition to the five major announced projects, Trimble says he knows of two or three others that developers are trying to put together. Trimble, whose agency has been at the center of downtown’s rebirth, with Horton Plaza and several apartment and condominium projects, says that even if several developers decide to move forward simultaneously, it won’t stop downtown’s momentum. If anything, it will add to what he describes as downtown’s “ratcheting effect.”
“It’s possible four new buildings could begin (construction) in the next two years,” he said. “I’m not uncomfortable with that. So it’s overbuilt, so what?”
