Developer Shakeout to Continue Into ‘90s : Construction: Industry observers predict real estate profits will shrink as those who ignored the market and built for tax advantages pay the price.

Saddled with a nationwide surplus of office buildings, the real estate industry faces shrinking profits and a continuing shakeout of developers in 1990, according to a new industry study.

Next year “will be painful,” said Charles Shorter, senior vice president of Real Estate Research Corp., which recently issued a bearish annual report on the industry.

“Some will drop out,” Shorter said of developers. “Not many people will make money, and those who do will work hard to earn every penny they make.”

Most industry officials, the report said, expect 1990 to be a worse year for the real-estate business than 1989.

The report, which was based on interviews with more than 100 major developers, lenders and real-estate investors, said 65% of those officials are less bullish about next year, while 13% are more bullish.

Another 22% are bullish about their own firm’s prospects, but are not optimistic about the industry overall.

Most of the officials interviewed do not expect conditions to improve until the mid-1990s.

“In general, office markets are overbuilt from coast to coast,” said Douglas A. Tibbetts, president of Equitable Real Estate Investment Management Inc., which manages real estate for pension funds and sponsored the report.

“We’ve got to get more order and discipline,” Tibbetts said.

The excess is largely the legacy of “capital driven” development, real-estate investors who were building for tax advantages rather than to satisfy tenant demand, Tibbetts said.

Of the real-estate executives interviewed, 28% said their businesses plan to expand in 1990; 20% said they expect to contract and 52% said they anticipate no change in scale.

A geographic ranking of real-estate markets underscored the industry’s gloom.

Los Angeles was ranked by RERC’s interview subjects as the most desirable city for investment, development and lending with a rating of only 7.6 on a 10-point scale.

The Washington area placed second with a 7.3 rating, followed by San Francisco at 7.0. Noting that real-estate people are known for optimism, Tibbetts said the low ratings convey a strong message.

The report was prepared before the Bay Area earthquake, and Shorter said he could not predict how the quake might change investors’ attitudes about West Coast real estate.

Earthquake-related damage to Equitable’s $3 billion worth of San Francisco property is expected to total less than $5 million. Buoyed by its industrial base, a strong supply of affordable housing and a relative absence of restraints on development, Chicago ranked fourth.

Chicago was followed by Seattle, which is perceived as a “spillover city” for people who are growing disenchanted with California’s quality of life.

New York and Boston, which have ranked among the most desirable major cities for real-estate investment in past years, slipped to sixth and seventh. High prices, overbuilding and a sense that economic growth has peaked have tempered their appeal, the report said.

The least desirable major markets were Houston, Dallas, Miami, Phoenix and Denver, in descending order.

Even so, investors are regaining interest in Texas property, RERC said. That could be the beginning of the depressed state’s long journey back to economic health, but the road has many pitfalls. Many vacant buildings constructed during the Texas boom will not hold up well and could have difficulty competing against new buildings if construction resumes, RERC said.

“Much of the property to be acquired is junk,” the report said. “Many buildings should probably be torn down.”

The cleanup of the savings and loan crisis, which includes the sale of $150 billion worth of real estate, is one of the darkest clouds over the real-estate industry.

A rapid unloading of the property could flood real-estate markets, while a glacial liquidation could hurt the real-estate industry by prolonging uncertainty about property values.

The downturn in U.S. real estate is expected to spur American investment in foreign real estate and development abroad.

Interest focuses on Europe, where real-estate markets are not overbuilt and American design and construction technology have a competitive edge, RERC said.

A large number of developers are likely to attempt projects in Europe, but only a few are likely to profit from the effort, the RERC report predicted. The unfamiliar and relatively uncompromising local approval processes in Europe will be difficult for Americans to surmount, and building overseas will pose logistical problems, RERC said.