Orange County : 1990 : THE YEAR IN REVIEW : Overbuilt to the Hilt, O.C. Office Space Goes Begging
Last month, a commercial real estate broker camped out in the lobby at Price Waterhouse for three hours until the partner in charge of the accounting firm’s Newport Beach office agreed to see him. The broker had been told to stay all night if necessary.
Price Waterhouse is leaving high-priced Newport Center and needs 40,000 square feet of office space, a sizable amount. So desperate are landlords to fill their empty buildings that the firm has been besieged with offers. (The broker, incidentally, didn’t get a deal; Price Waterhouse had already narrowed its search to a few buildings.)
Developers have built more than half of Orange County’s 40 million square feet of first-class office space in the last five years. Eleven million square feet of it--equal to 550 floors of the average high-rise office building--sits vacant.
Landlords charge rock-bottom rents, offer free parking, even part-ownership in the building--anything to get tenants in the door.
The construction boom was never totally driven by a need for all that space. The lenders simply had a lot of money to lend, and the development companies had grown so large that they had to either keep building or start to shrink.
This year, however, the tidal wave of construction finally slowed. The money dried up after the thrift industry crashed and the banks came under the worried scrutiny of federal regulators. But it appears to be too late. At the rate tenants leased new space last year, it will take four years to fill all the empty office space on the market. And there was 3 million more feet under construction near the end of the year.
“The whole thing’s kind of scary,” says Scott Perley, a commercial real estate broker. “The figures show that office space is still growing at 7% a year. But jobs in the service industries are only growing at 3%, and it’ll probably be less next year.”
Meanwhile, real estate is such a large part of Orange County’s economy that the construction slump promises to make the recession here that much deeper.
Here’s a look at how four people in four different parts of the real estate business are coping with the downturn:
At the International Brotherhood of Electrical Workers offices in a rundown Santa Ana neighborhood, Bob Balgenorth is thinking about the last recession, when home builders broke the construction unions in Orange County.
Now construction is going down the tubes again and the big office and hotel projects that are the building unions’ last toehold here are vanishing. Nine thousand construction workers lost their jobs in the last year, a big chunk of the 50,000 people unemployed in the county.
Will the big construction companies take advantage of this recession to try to smash their unions, too?
“Builders always kick that idea around,” Balgenorth says. “The first thing that happens in a downturn is people say: ‘Where can I cut costs? Can I cut out the union?’ ”
The local IBEW is so weak compared to its counterparts in union towns such as New York that the 1,600-member local sometimes subsidizes part of its members’ $24.90-an-hour wage so union contractors can bid for business as low as non-union contractors.
That kind of thing, Balgenorth says, makes it harder to dislodge the local unions nowadays.
Meanwhile, the places construction workers are likely to be looking for jobs in the next few years are in public-works programs such as highway construction, Balgenorth predicts.
And on the bright side, the downturn may even bring local unions some new members, he says.
“If you’re working for a non-union guy for $12 an hour and he cuts your wage to $10, what are you going to do?
“You’re going to think about joining a union.”
Some people think it’s significant that Ray Wirta, named president of the Koll Co. early this year, has spent much of his career in charge of managing buildings.
For that, they say, is how Koll and other developers are going to earn most of their money for at least the next several years.
Look at the figures: Last year Koll developed 3.5 million square feet of space, an amount equal to about a third of New York’s giant twin World Trade Center towers, enough to make the Newport Beach-based company the biggest developer on the West Coast.
This year, however, it was 3 million square feet. And next year, it’ll be 1.5 million, Wirta says.
From his office on the top floor of Koll’s sleek, three-story glass building, Wirta can look out on the urban canyons of the John Wayne Airport area, a neighborhood where only 20 years ago quail nested in open fields.
Koll was the first big developer to see the potential in those fields. And it was one of the first to get rich partners--insurance companies, savings and loans--to put up all the money to build offices and warehouses, while Koll usually put only its expertise into the deal with little risk to itself. In this way, Koll and other companies used someone else’s money to grow much larger than they could have otherwise. But they also helped build the glut of office space in places like Orange County.
Now, some experts say that development companies such as Koll will eventually turn into just another type of service company, developing buildings for a fee for corporations planning to move into them.
Not quite so, says Wirta, who predicts that the vacant offices and factories will fill up sooner than most people expect. That will mean new demand for the type of speculative buildings that Koll constructs with no particular tenant in mind, although probably less demand than in the past.
“Most developers aren’t interested in being employees,” he says. “They’re interested in the upside of building and owning real estate for themselves.
“There’ll always be those kinds of deals in this business,” he adds. “After all, we’re not building cars.”
A few miles down the San Diego Freeway, Dan Heinfeld shows a visitor the expansive view of the mountains from his new offices in an Irvine industrial park.
LPA, an architectural firm, moved its sleek office furniture and drafting tables into the new building in May so that it would have room to expand. Instead, the firm laid off 15 of its 90 people over the next few months.
The ripples from the construction slump are spreading to all sorts of other real estate businesses that once grew like weeds--commercial brokerages, mortgage brokers, space-planning companies.
Recently, jobs in the real estate industry stopped growing; in fact, they dropped by 400 or so in October, to 29,000.
For the architects--including LPA--that means cutting fees to compete for a diminishing amount of work.
But after the last recession, LPA began to branch out from designing “spec” buildings, risky projects built by developers who speculate that they will soon fill the building with tenants.
Sometimes the new strategy backfired. For instance, LPA’s first stab at an airport terminal--at John Wayne Airport--turned into a public relations disaster after millions of dollars in cost overruns.
But now that there are far too many spec buildings sitting empty, and little reason to build more, diversification makes more sense.
Taking up the slack are some projects that are smaller and less glamorous than a firm the size of LPA might have done in the past. The company is doing work for public agencies such as the state university system and city governments, which are more likely than private companies to build through a downturn.
Says Heinfeld, president of the firm’s Irvine office: “These days, there are very few of these jobs architects will turn up their noses at.”
A few months before the onset of a recession might not seem the best time to start a new company, but not, apparently, to Harold Street. In August, Street left the Koll Co.--where he was a top executive for marketing and development--to move around the corner into his own office.
Now, he has hooked up with WSGP Partners L.P., a company started by former Treasury Secretary William Simon. WSGP used to be a financial partner with developers in building projects; now, it’s turning into a buyer.
WSGP has already rounded up Tokyo Fire & Marine Casualty, the world’s largest property and casualty insurance company, as a fellow investor. Street has a deal to raise hundreds of millions of dollars from Pacific Rim, European and American investors who might like to buy real estate over the next few years at bargain-basement prices.
Why so cheap? One big reason: Thrifts that invested in real estate--and must now sell within a few years under new federal regulations--will be willing to make deals, Street says. Then there are the banks that will be foreclosing on buildings and will be anxious to get them off the books.
And few buildings are being sold now, which means sellers will grow even more desperate. The Japanese, once big buyers, have troubles of their own with higher interest rates and declining real estate values at home. The big U.S. pension funds are waiting for prices to drop still further--below what it would cost to build the buildings, real estate brokers say--before scooping up values in what the industry calls “vulture” deals.
“I’d advise people with capital to get ready for the period of the most opportunity I’ve ever seen,” Street says, adding:
“In another two years or so, there’ll be an opportunity to acquire spectacular assets at historically low prices.”
Building Boom Goes Bust After the recession of the early 1980s, there was a big demand for office space in Orange County, and developers rushed to meet it, bringing more than 6 million square feet of space under construction in 1984. The figure didn’t dip below 4 million square feet until 1989, after which the office vacancy rate dropped into the low 20% range and has stayed there. New construction appears to be slowing, but so does absorption, or the amount of new space taken off the market each year by tenants. Vacant Square Feet In millions of square feet: ‘84: 2.4 ‘85: 5.3 ‘86: 6.4 ‘87: 8.8 ‘88: 9.7 ‘89: 10.6 ‘90*: 10.6 Vacancy Rate ‘84: 12% ‘85: 23% ‘86: 24% ‘87: 23% ‘88: 23% ‘89: 21% ‘90*: 21% *Through September 1990 Source: Grubb & Ellis Orange County Research Services Group
