REGIONAL REPORT : Office Boom Goes Bust : Real estate: Southern California is in its worst commercial-building slump in years. Some say a recovery is up to a decade away.

Buoyed by the “building of the year” award that a trade group gave its first office tower in downtown Los Angeles in 1989, Metropolitan Structures West Inc. broke ground that year on an even grander $326-million skyscraper hoping to attract tenants as fast as its sibling did.

But four months before California Plaza II will open, company officials are not optimistic. The 52-story tower is just 30% pre-leased and faces stiff competition in a crowded market. Five other office buildings are expected to open downtown in the next six months.

California Plaza II is forecast to lose as much as $33 million if it can’t attract more tenants, experts say. And Metropolitan won’t begin to make money until it can rent at least 75% of the building’s 1.27 million square feet for at least $30 a square foot.

“Everyone is concerned--from our lenders on down,” said Metropolitan Structures President Nyal W. Leslie.

Metropolitan Structure’s predicament highlights how treacherous Southern California’s commercial real estate market has turned. The region is swimming in tens of millions of square feet of unneeded office space in the wake of a decade-long building boom that was fueled by developers’ overly optimistic projections of demand.

The recession has compounded matters, forcing hard-pressed building owners to slash rents and subsidize the furnishing of office space to attract tenants. As a result, some building owners are having trouble repaying loans.

Although Burbank, Glendale and some other submarkets have escaped much of the crunch because growth restrictions limit office building there, most of the Southland is mired in the worst commercial real estate slump ever--with analysts predicting that a recovery may be five to 10 years away.

Low rents and high vacancies have dealt a blow to Orange County developer McLachlan Investment Co. Last January, First National Bank of Boston took back the developer’s posh nine-story office building near John Wayne Airport.

In September, a federal bankruptcy judge cleared the way for Swiss Bank Corp. to foreclose on the Bank of California Plaza building at 110 West A St. in San Diego and two 500,000-square-foot office towers at 10960 and 109880 Wilshire Blvd. in Los Angeles. The ruling came after owner VMS Realty Partners of Chicago was found in default on $226 million in mortgages on the properties.

And Watt Industries, a Los Angeles home builder that had hoped to move into office construction in a big way with its Watt City Center Project at 7th and Bixel, has instead had to sell its corporate jet, cut its 800-person staff by 350 and suspend work on its 550,000-square-foot City Center project. Besides the financial drain the City Center project posed, Watt recently paid $13.3 million to settle a defective-construction suit brought by Villa Marina East V Homeowners Assn. in Marina del Rey.

Metropolitan’s Leslie would not comment on possible losses facing his company from the project, but he said anxiety over the development often awakens him in the wee hours of the morning. “I think this is the last speculative office building you’ll see anyone build for a while,” he added.

Despite the glutted market, most local developers have escaped the financial pummeling that has humbled such real estate moguls as New York’s Donald J. Trump and Atlanta’s John C. Portman Jr. Portman is in a real estate partnership that this month sought protection in federal bankruptcy court for the troubled Westin Bonaventure hotel in downtown Los Angeles.

Santa Monica-based McGuire Thomas Partners, which has built more than half a dozen major buildings in the Southland, is one local developer that is prospering. The partnership, which built the First Interstate World Center and Colorado Place, said it has the land as well as the plans to build 30 million more square feet across the nation during the next decade.

Southern California’s diversified economy has helped forestall a widespread calamity thus far.

Although office rents have fallen to $25-$35 a square foot, that is at least twice the rate that prevailed during the Texas real estate crash of the mid-1980s. The California Mortgage Bankers Assn. says that as of June 30, 2.52% of $23.7 billion in commercial real estate loans held by its members were delinquent or in foreclosure--less than half the national figure of 5.41%.

“The recent trends have caused us some concern, but I think the fundamental reason we invested in Southern California still holds true--growing investment from the Pacific Rim and expanding trade,” said Daniel W. Cummings, managing director of LaSalle Partners Ltd. The Chicago-based pension fund advisory group has $1 billion, or nearly 20%, of its real estate portfolio, invested in Southern California.

Still, the commercial real estate downturn has sparked a painful retrenchment that has dwarfed even that of California’s huge aerospace industry. And many experts fear that the crimp may keep the region’s economy depressed for months to come.

Average rents in Southern California office buildings have declined 10% to 20% since the early 1980s. More than 40,000 construction jobs have been lost in the state since February, 1990, as non-residential building plummeted 42% to a seasonally adjusted annual rate of $8.2 billion, according to the Construction Industry Research Board.

And at least 10 Southern California commercial brokerages have reduced their operations or gone out of business since April, including giant CB Commercial Real Estate Group Inc. and Illiff Thorn & Co., which closed its 20-person Irvine office Oct. 18.

“There is not enough business to support the number of people out there” in the brokerage business, said Thomas B. Gibson, who has been job hunting since he was laid off as Illiff’s vice president/regional manager. “Everybody I know is watching their expenses” and letting others pick up the meal check where possible, Gibson said.

The commercial real estate downturn is causing reverberations in the rest of the economy also as major lenders, banks, thrifts and insurance companies contend with more loans gone sour. California banks’ non-performing loans as a percentage of assets rose to 3.5% in June from 2.9% last year.

“It’s a blood bath out there right now,” said Paul Elanese, president of Koar Inc., which recently tabled a downtown office building for which it had obtained financing and city approval. “This is the toughest time I’ve seen it in the 18 years I’ve been in L.A.”

Besides the negative effects of the slumping economy on office demand, the expanded use of computers in the 1980s and the increased focus on office efficiency have slowed the leasing business.

“It’s a good time for space planners because there is a lot of activity on the part of tenants moving,” said Steve R. Dubin, a vice president at Reel/Grobman & Associates. “And whether (tenants) can articulate it or not, they want to spend less money per foot and pack more people in less space than they did in the past.”

A healthy office market typically boasts a vacancy rate of less than 8%. But with one-fifth of Southern California’s 250 million square feet of space vacant, many locales have vacancy rates nearly three times that level.

The problem of excess office space is perhaps most evident in Los Angeles, where nearly 19% of the 34 million square feet is vacant. Some downtown structures, such as the WTC building at 1100 Wilshire Blvd., are nearly half empty.

However, the office glut is more widespread in other areas, particularly in overbuilt Orange County (vacancy rate 23%), San Diego (vacancy rate 22.6%) as well as around the Los Angeles International Airport, where cutbacks in aerospace have left a stunning one-third of the 4.3 million square feet of office space empty.

TCW Realty Advisors, a Los Angeles-based real estate consulting firm, estimates that, based on last year’s office leasing rate, it will take about 9.3 years to reach 95% occupancy in Los Angeles, 5.5 five years in Anaheim and five years in San Diego, Ventura and Oxnard.

The demand for office space is so slack in the region that lawyer Robert Rosenstiel recently took out a newspaper ad offering $1 million to anyone willing to take over the balance of his Century City law firm’s four-year lease. Despite the unusual offer of 43,000 square feet of space at “below market” rates, “we’ve had had little response” and no takers, Rosenstiel said.

How did things get so bad?

Like other overbuilt areas in the country, proposals for new office buildings in Southern California--even ill-advised ones--proved alluring to developers and lenders because of the generous loan fees such projects generate. Before an office tower is even begun, a builder gets a fee amounting to 3% of loan proceeds to pay expenses such as planning and engineering. Similarly, the lender is paid “points,” or fees amounting to as much as 6% of the loan.

Many lenders and developers based their blue-sky development expectations on the seemingly insatiable appetite foreign investors had for U.S. real estate during the 1980s. According to the accounting firm Kenneth Leventhal & Co., Japanese investors alone purchased $28 billion worth of U.S. real estate during 1989 and 1990.

Among the most aggressive of the Japanese buyers was Shuwa Investments Corp. After acquiring its first U.S. property in 1986--Los Angeles’ Arco Towers--the firm went on to buy $3 billion in U.S. real estate. Today, Shuwa and other Japanese firms own one-third of the major office buildings in downtown Los Angeles, according to Cushman Realty Corp. of Los Angeles.

The easy money from lenders and the promise of foreign buyers proved especially enticing to high-risk developers, who built towers on speculation, with borrowed money, and hoped to find tenants after buildings were completed.

Some who rolled the dice, won. For example, Mitsui Fudosan U.S.A. Inc. completed the $270-million, 52-story Sanwa Bank Plaza in downtown Los Angeles last May before it signed up major tenants. Yet it has managed to lease 85% of its 1 million square feet of space because of the building’s efficient design and central location, said Okitami Komada, president of the development firm.

But most developers bet wrong when they decided that they could defy the growing glut of space.

“In real estate, you start a lot of things in an atmosphere that is completely different than when you finish it,” said Ted Cox, president of Watt Industries. “I think a lot of people have learned a lesson. . . . We certainly don’t have any projects in the pipeline.”

Offic Space Glut

The real estate construction boom of the 1980s has resulted in a dramatic rise in office space in the Southland.

Idle Office Space

A healthy office market typically boasts a vacancy rate of under 8%. But in the wake of a 1980s commercial real estate construction boom, locales have vacancy rates nearly three times that level.