Building a Hollow Skyline

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Many real estate firms are tempted to build and build because healthy companies can get loans with few questions asked. "The lender will look at the developer's financial statement instead of the feasibility of the project," says John McKnight, senior vice president of San Diego's Home Federal Savings.

Developers often make sound decisions that go wrong during the time span between groundbreaking and ribbon cutting. A builder may draw up plans when the market is favorable, only to find a surplus when the project is completed two to four years later. "At the time they make the commitment to go ahead, they may not realize how many other people are making the same decision. If one were not naturally an optimist, one would never choose to be a developer," says Robert Patterson, a Los Angeles-based managing partner of Laventhol & Horwath, an accounting and consulting firm.

For renters and buyers, the glut brings fire-sale bargains. Office-building owners offer concessions of as much as a year's free rent on a three-year lease. Condos, especially luxury models, are selling on the cheap. Goldrich & Kest, developers of the 64-unit Four Seasons complex in Beverly Hills, cut the price of a typical condo apartment from $750,000 to $500,000. "The building was an absolute knockout, but the market fell apart," says Warren Breslow, a general partner in the company. "We slashed prices and took a substantial loss."

Not all cities have surpluses of space. Chicago's office vacancy rate is a relatively low 13.7%, and in midtown Manhattan just 7.4% of the offices are empty. Only a decade ago, Manhattan suffered an office surplus that sent rents plummeting by 50% or more. But at the moment, New York's role as financial capital of the world is keeping space in demand despite a building boom. Manhattan's current construction totals 14.5 million sq. ft., more than is under way in downtown Los Angeles and Chicago combined. New York City's one area of weakness is its condo market, where sales and prices have leveled off.

In some cities, officials have begun to take action against overbuilding. San Francisco's board of supervisors, mourning the "Manhattanization" of their once quaint downtown, last month adopted rules that will sharply restrict the building of high-rises. The Boston Redevelopment Authority has offered a plan for limiting construction in the city's downtown, blaming development for creating canyon-like streets, blocking sunlight and overwhelming historical buildings.

Many real estate advisers are warning their clients against investing in office buildings, deluxe condos or other large-scale projects. But now is just about the time when the most freewheeling investors like to buy up the property that less daring owners are selling. Says Berkeley's Rosen: "A glutted market creates a lot of distress, but also great opportunities. The best time to buy is when the blood is in the street." He warns, though, that the bloodletting for developers and lenders will continue for at least another year. Says Jerry Speyer, managing director of the Tishman-Speyer office-development company: "Things will get worse before they get better." --By Stephen Koepp. Reported by David S. Jackson/Houston and Thomas McCarroll/New York