Downtown Blues

By Barbara Rudolph

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.

With reporting by Anne Constable/London and Thomas McCarroll/New York