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Commercial Real Estate | REPORTER'S NOTEBOOK

Worried Pros Look Past Good Times


DALLAS — In sharp contrast to the backslapping bonhomie of a year ago, the mood among many of the country's top real estate professionals was decidedly gloomy last week at the Urban Land Institute's fall meeting.

Instead of toasting some of the highest rents and occupancy levels of all time, developers, brokers and investors roaming the halls at the convention were throwing around words like "credit crunch," "deflation" and "recession" and generally crying in their beer.

Turmoil in the global financial markets, a plunge in real estate investment trust share prices and a shrinking pool of capital for investment and development has convinced even the most optimistic of developers that a U.S. real estate slump is in the offing. Most attendees were trying to figure out what to expect and how to deal with it. There were few answers.

What's most frustrating, developers say, is that this time, it isn't all their fault. Unlike the last real estate cycle, overbuilding has been isolated to just a few markets, including Las Vegas, Phoenix, Atlanta (and, some say, the host city of Dallas). Interest rates are relatively low, and there hasn't been the same level of rampant overpaying for properties that marked the late 1980s. Rents and occupancy are high in most markets.

"U.S. real estate fundamentals are still strong. In the 1990s, demand has clearly outstripped supply," said Stan Ross, vice chairman of EY Kenneth Leventhal.

In 1989, the nation's property prices were peaking, even as vacancy was climbing to near 17% and rental rates were falling, according to the National Real Estate Index. So if everyone's being so good this time, why the pessimism?

Some researchers and developers think we may be talking ourselves into a real estate recession. Others think we may be learning to recognize trouble signs a little sooner.

"The market is now starting to anticipate an economic downturn," said Mark Tercek, a managing director of Goldman, Sachs & Co. "And that's resulting in weaker demand for real estate."

One consolation for developers and landlords is that the country's real estate markets aren't expected to fall as hard as they did last time. And they won't stay down as long.

Indeed, Michael Giliberto, head of research for J.P. Morgan Investment Management, thinks real estate values may plateau rather than peak. The industry is losing some of its volatility, analysts say, because more buildings and debt are publicly owned and more large real estate firms are facing the scrutiny of Wall Street when they make deals.

In fact, Tercek thinks REIT performance will soon mirror more stable industries like railroads or mining. He says the plunge in REIT prices this year was the first test that Wall Street could rein in the overzealous development and overheated investment that eventually accompanies economic good times.

As another panelist put it: "The bad news is the REIT market is down this year. The good news is the REIT market is down this year."

Southern California property owners who were looking to sell to these giant investors may not share these analysts' enthusiasm. But they should be glad that Wall Street has put a lid on the gung-ho development that characterized the previous cycle. Less building means less competition for their properties and higher rents and property values.

Still, REITS and other big buyers aren't buying right now. They've been dropping out of deals across the country, owing to the slide in REIT shares and lenders cutting back or renegotiating commercial loans they intended to securitize.

Those still lending are demanding higher rates and more equity, which has made some previously agreed-upon deals too expensive. Others have turned off the supply of money. Real estate lending plunged to $9.2 billion in the second four months of this year from $39 billion in the first four months, according to the index.

The only ones not fretting about news of a downturn are well-connected players with smooth access to money, like Sam Zell of Chicago-based Equity Office Properties Trust and Michael Fascitelli of Vornado Realty Trust.

With competition waning, the two REIT bosses expect properties to become a much better buy in the next couple of years. Already, deals that were going for over $100 million in midtown Manhattan have dropped by millions of dollars, says Fascitelli.

And even in Southern California's resurgent economy, experts say, commercial prices are near their peak or are starting to edge down as the intense bidding from REITs and other big investors subsides.

Does that mean Southern California will follow the rest of the country and have the shortest economic rebound on record? There's still a year or two of steam left in the region's growth engine, analysts say. But a slowdown in exports and lower wages for construction workers in other areas should soon dampen demand for local property. So, the message is, enjoy it while you can.

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