TIME: Almanac 1993/TIME Almanac 1993.iso/time/110590/1105206.000

Text File | 1992-08-28 | 11.4 KB | 242 lines

                                                                                BUSINESS, Page 50

Downtown Blues


No longer highflyers, commercial real estate developers face an
epic slump that has put their market "in the gutter"

By BARBARA RUDOLPH -- Reported by Anne Constable/London and
Thomas McCarroll/New York


    Few architects and developers have reshaped the American
city as dramatically as John Portman has done in the past
quarter-century. From the hulking Marriott Marquis hotel in
Manhattan to the sprawling Embarcadero Center office complex
in San Francisco, Portman has left an imposing mark on urban
skylines. But the Atlanta-based master of the vaulting atrium
and the skylighted ceiling faces a severe cash crunch. In
October, burdened by more than $2 billion in debt and hurt by
low occupancy rates in many of his buildings, Portman
surrendered to creditors his control of Atlanta's 13-block
Peachtree Center, the cornerstone of his worldwide empire.

    Portman is not the only highflying mogul to feel the
harshness of a downward real estate cycle. In London and dozens
of U.S. cities, the commercial-property market is reeling.
Hundreds of empty office towers and abandoned construction
sites dot downtown neighborhoods. In most places there is no
new construction. Office rents are plunging, and vacancy and
delinquency rates are soaring. Overleveraged developers are
being forced to refinance their loans and offer sweetheart deals
to prospective tenants -- free rent for a year, say, with an
exercise room thrown into the bargain. Declares Richard Peiser,
director of the Lusk Center for Real Estate Development at the
University of Southern California: "We are going through the
greatest restructuring of the real estate industry in this
century."

    The industry's woes cast a gloomy shadow last week over the
normally upbeat annual meeting of the American Bankers
Association in Orlando. Attendance was off nearly 20% from last
year as many members stayed home to tend to their troubled
portfolios. Those who showed up foresaw no relief from the real
estate depression. "I'm not planning on it getting any better
in 1991," said Thomas Labrecque, president of Chase Manhattan,
which lost $623 million in the third quarter of 1990, largely
because of bad mortgage loans.

    The real estate contraction represents, in effect, the
unraveling of the 1980s. For much of the decade, economies were
growing, demand was strong, and, best of all, money was easy
to come by. Financial institutions, especially American savings
and loans, fell over themselves to lend to real estate
developers. Says Pamela Rose, president of Chicago-based Rose
& Associates, a real estate brokerage firm: "The  fatal disease
of this business is that developers love to develop. Real
estate people simply lost control because there was so much
money available." Concurs Richard Kateley, chief executive of
Chicago's Real Estate Research Corp.: "The '80s were like a
carnival, with foreign investors, banks and pension funds all
competing to pour money into developers' pockets."

    The forces that propelled the expansion of the past decade
are now pushing in the opposite direction. The U.S. and British
economies are either in a recession or on the brink of one, and
corporations are shrinking their office space. At the same
time, developers are feeling the effects of a global credit
crunch. Finally, banks are wary of assuming greater exposure
in the real estate business. James Yasser, a senior vice
president at Milstein Properties in New York City, sounds a
familiar refrain: "Everything went right during the '80s, and
now everything is going in reverse."

    Experts calculate that there is so much office space
available in the U.S. that even if all new construction were
cut off, it would still take eight years to fill the empty
spaces. The average American metropolitan area faces a 20%
office vacancy rate. The average is closer to 30% in some
cities, including New Haven, Conn.; Phoenix; Dallas; and San
Antonio. Commercial-mortgage delinquencies are running 25%
ahead of last year and are fast approaching the record set in
1976.

    More and more developers are landing in bankruptcy court.
Among them: Washington tycoon Jeffrey Cohen, who filed for
bankruptcy after he defaulted on more than $11 million in
loans. Others are opting for an only slightly less painful
alternative: renegotiating their loans in excruciating
"workout" marathons that leave the developers with less control
over their holdings. John Robbins, a managing partner at
Kenneth Leventhal & Co., an investment firm that handles
workouts, reports that his company's business has quadrupled
in the past year. Says Robbins: "The real estate market is in
the gutter -- and that's being kind."

    Even for the most prudent deals, financing has become
elusive. Banks require developers to put up cash or equity
amounting to 30% or 40% of a property's value and demand that
developers have lease agreements for half their commercial
space before they can qualify for a loan. A few years ago,
established developers were able to strike deals with banks
without arranging any advance leases. Says New York City
developer Larry Silverstein: "It is almost impossible to finance
a new deal today."

    Silverstein knows a lot more about bankers than he used to.
His lenders have been keeping a close eye on the financial
status of his two largest projects: midtown Manhattan's A&S
Plaza and 7 World Trade Center in the financial district. The
1 million-sq.-ft. A&S Plaza stands one-third empty, while the
2 million-sq.-ft. World Trade Center site is largely rented
only because of substantial givebacks.

    In delicate straits as well is real estate developer William
Zeckendorf Jr. He was 36 in 1965 when his father, the brash and
bold William Zeckendorf Sr., lost his fortune, which in the
early 1960s might have been worth as much as $500 million. The
son has been relatively cautious, but he is nevertheless
feeling the pinch. His Zeckendorf Towers in Manhattan lost its
largest commercial tenant, Integrated Resources, when the
investment syndicator filed for bankruptcy earlier this year.
Still, because most of his debts are corporate and not
personal, Zeckendorf stands to lose a relatively modest $7
million.

    In London developers are feeling nostalgic about the
mid-'80s, when the economy was growing and money was flowing
freely. Today real estate firms in Britain are confronting base
interest rates of 14%, stagnant growth and a lingering hangover
after years of overbuilding. Commercial rents in London, which
reached about $130 per sq. ft. a year ago, have fallen nearly
25% since then. Chris Walls, a property analyst at Salomon
Brothers in London, predicts that rents will decline to less
than $100 per sq. ft. by the end of the year. The vacancy rate
in central London is 11%, up from 5% in mid-1989. In the City,
London's financial district, it hovers around 15%.

    At the center of the most recent real estate development in
London are the Toronto-based Reichmann brothers. Through their
family-held firm, Olympia & York, they have invested about $2
billion to develop Canary Wharf. The $8 billion, 71-acre
project on the Thames, three miles east of the City, is
Europe's largest commercial development and by far the
Reichmanns' most ambitious. The brothers are seeking $2.2
billion in long-term financing for Canary Wharf from a
consortium of lenders. In London banking circles, the consensus
view is that Olympia & York will eventually get the money.

    The Canary Wharf project has gradually been filling up. Of
the 4.3 million sq. ft. of space that will be available next
spring, about half has been rented. Most of the tenants are
American firms or British subsidiaries of U.S. companies,
including American Express and Morgan Stanley International.
But the weak dollar has raised concern that other U.S.
companies will postpone plans to expand in Britain. At the same
time, the Reichmanns have yet to convince many London firms
that Canary Wharf's distance from downtown is not a problem.

    Olympia & York has had to offer more than a few inducements
to attract tenants. For starters, rents are quite low: about
$55 per sq. ft.  Olympia & York has also offered to assume the
costs of breaking a tenant's existing lease and has been
willing to assume expenses for moving and for decorating
offices. Says Salomon Brothers' Walls: "If a company is willing
to move, it can halve its occupancy costs."

    The Reichmanns are implementing a long-standing plan to sell
a 20% stake in their U.S. real estate portfolio, which is
valued at more than $2.5 billion. But the brothers deny that
they are caught in a cash crunch or have soured on American
holdings. "Yes, there are excesses in the American system, but
that system has built the strongest economy in the world," said
Paul Reichmann, the family's chief investment strategist, in
an interview with TIME. "The excesses have to be cleaned up for
the system to get back to normal. In two or three years it will
be totally back to normal." By early 1991, he said, Olympia &
York will break ground for a new office tower on Manhattan's
Park Avenue.

    As values continue to fall in New York City and London, the
dominant buyer of recent years -- the Japanese investor -- is
much more cautious about staking any new claims. Now that
Japan's stock market has collapsed, with the Nikkei average
down nearly 40% since the beginning of the year, some analysts
predict that the country's real estate bubble might be the next
to burst. At the same time, Japan's large financial
institutions are finding that returns from their American real
estate assets are no longer so attractive. The Japanese have
also been hit by rising interest rates and tightening credit.
"The predominant feeling is fear and pessimism," admits a
spokesman for Mitsui Real Estate Development Co.

    Japanese banks, like their counterparts in New York City and
London, are keeping a wary watch over the slump in real estate
values. All have more outstanding loans to overleveraged
developers at home and abroad than they care to contemplate.
In August, Moody's Investors Services, a U.S. firm that
analyzes the balance sheets of corporations and banks around
the world, downgraded its long-term credit ratings for two big
Japanese banks, Dai-Ichi Kangyo and Fuji Bank, from triple A,
the highest level, to double A. Moody's cited excessive lending
to the real estate sector as a key reason for the revision.

    U.S. banks are in even worse shape. Chemical Banking Corp.
sharply cut its dividend in October, following a $44 million
loss for its third quarter. Most of its problems stem from sour
loans to real estate developers. Bank of Boston lost $255
million during the third quarter. James McDermott, a banking
analyst at Keefe, Bruyette & Woods, says the fallout from the
commercial real estate slump "is expected to get much worse
before it begins to improve."

    No one knows that better than real estate developers. Those
who overextended themselves during the flush years hope to hang
on. The rare ones with cash to spare will eventually start
scouting for bargains. And sooner or later, someone might get
as lucky as developers in the gloom-and-doom 1970s who managed
to pick up prime real estate in New York and other cities for
a song.