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'Records, records, records' is new real estate mantra

In a year that saw new breakthroughs at nearly every turn, 1997 will go down as 'Year of the Deal.'

According to almost all indicators, the flow of capital to real estate was at record levels," says Richard Carlson, managing director for Real Estate Services at Deloitte & Touche in Chicago.

Carlson maintains that the volume of capital coming into the real estate sector was justified as property markets continue to improve. "Rents were up and vacancies down in almost every sector, while commercial mortgage-backed securities and real estate investment trusts had a great year."

By the end of 1997, when the equity markets were in turmoil, interest rates were low and there was little excitement about bonds, the only stable but attractive place to put capital was real estate - an attractive investment for at least the past three years.

REIT capitalization and CMBS together represent a quarter-trillion dollars of investment, about 6% of the total equity and debt invested in U.S. real estate, notes the 1998 edition of Comparative Statistics of Industrial and Office Markets, a publication of the Society of Industrial and Office Realtors, Chicago. The success of REITs and CMBS also represents the continuing influence of Wall Street in the asset class. Shifts in the pricing levels set by Wall Street are going to be influential on all buying and selling activities. Thus far, Comparative Statistics notes, Wall Street's in-roads into the real estate business have been advantageous as the capital markets flooded money into the sector - a major accomplishment considering how "illiquid" real estate seemed at the beginning of the 1990s.

Due to Wall Street's ability to pump capital into the industry, mergers, megamergers, corporate acquisitions, portfolio acquisitions and one-off property deals proceeded at a record pace throughout the year. By the end of 1997, REITs had accumulated about $50 billion worth of real estate.

New York-based Landauer Associates and the Commercial Investment Real Estate Institute (CIREI) have been tracking real estate transactions and, according to their database, about $18 billion in transactions were completed during 1997. "This database has been accelerating in total volume over the past few years, and we expect sales in the current year to be up about 20% from a year ago," says Hugh Kelly, managing director of Landauer.

By Kelly's measure, REITs represented more than a quarter of all buying activity in the United States. Landauer and CIREI's numbers didn't even include a flurry of end-of-the-year activity.

Among the late deals squeezed in before 1997 closed were: American General Hospitality Corp. bought 14 hotels for $270 million from Financial Security Assurance; Boston Properties took a portfolio of nine buildings, valued at $139.6 million, from Mulligan/Griffin Associates; First Industrial Realty Trust paid $138 million for operations of closely held Sealy & Co. and $200 million for 106 properties from Pacifica Holding Co.; and Simon DeBartolo Group and Macerich Co. formed a joint venture to buy 12 regional malls for $489.5 million and the assumption of $485 million of debt.

In one of the bigger transactions at year's end, Camden Property Trust announced it would be acquiring fellow multifamily REIT, Oasis Residential Inc., in a deal valued at $504 million. Earlier in the year, Camden bought Paragon Group Inc. By the time its most recent transaction closes, Camden will have quickly grown to controlling more than 51,000 apartment units.

REITs take the spotlight REITs sold a lot of property and REITs bought a lot of property, says Simon Milde, chairman and chief executive officer of New York-based Greenwich Group International, but also very active were pension plans, opportunity funds, foreign investors, individual investors, corporate groups and limited partnerships. "When you look at the low yields of government bonds, the low yields with equity and then you look at the differential with what real estate is yielding at the moment and that is why everyone wants to invest in real estate," Milde says.

So much capital in the market represents a potential danger, says Maria Sicola, director of Research Services at Cushman & Wakefield in New York. It means aggressiveness in pricing and sometimes a lack of due diligence. A capital-driven market, not a demand-driven market, was one of the major problems that led to the great real estate recession of the late 1980s. "The good news," says Sicola, "is that there seems to be a lot more intelligence associated with the capital in this decade. Maybe that is Wall Street's influence. There is a lot more information seeking. Also REITs have to report to the SEC on an ongoing basis so they are providing information quarterly. It doesn't mean we still don't need to exercise caution, but investment is being done more intelligently than it was in the 1980s."

The amount of purchasing activity, especially by the REITs, Sicola says, has demonstrated a confidence in many of the real estate markets, almost all of which have produced good numbers in terms of occupancy and rates this year. The purchasing activity also drove up prices, but so far not out of line with supply and demand balances.

Newmark & Co. Real Estate Inc., a full-service real estate firm based in New York, celebrated a record year in 1996, but that is an old story because in 1997 its volume of business was 30% higher than the year before. "Like everything else, real estate goes in cycles," says Barry Gosin, Newmark's vice chairman and chief executive officer, "I don't know if we are at peak, but certainly we are still on the upside of the curve." This doesn't necessarily make Gosin sanguine. If the economy slows down in '98 as indicators are beginning to show, then "it is anybody's guess for 1998."

Indeed, the economic cycle has been extraordinarily beneficial to the real estate sector beginning about the middle of this decade. After years of downsizing, the industry began to feel healthier and started taking up space again. People began new businesses and they needed space. "As they did, there was no place to go except into existing space, and that got used up," says Charles Esler, chief executive officer at LaSalle Partners Management Services in Chicago. The office market was one of the last to improve, but it is healthy and once again in the eye of the buyer. "You are starting to see trades taking place at close to or below replacement costs," Esler notes, "and that would pretty much be an indication that the economics are going to favor new development" - which has already happened in retail, multifamily, industrial and hotel.

"It was a good year for real estate," Esler adds. "As a manager, we saw an awful lot of activity."

As a company, LaSalle is as good as any to represent what happened in real estate in 1997 - vast changes on the corporate level. Some companies disappeared, some got bigger, some became part of others, while others changed stripes. LaSalle made the most of the capital markets. In April, the company not only acquired The Galbreath Co., but it also went public. "Being a public company," says Esler, "gives us a very viable and real currency for doing a merger or acquisition. We don't have to go to the bank and get a loan or get a line of credit."

Consolidation becomes commonplace LaSalle wasn't the only real estate service provider taking a bigger piece of the market by acquiring smaller companies; its competitors were doing the very same thing. Cushman & Wakefield bought Premisys, PM Realty Group Investment Services took on National Equity Advisors, while CB Commercial nabbed Koll.

CB Commercial experienced a very busy 1997. The company also formed CB Commercial/Whittier Partners L.P. with Boston-based Whittier Partners, and it merged with REI Ltd., the holding company for all Richard Ellis operations outside the United Kingdom. The latter deal created a global commercial real estate firm with 8,000 employees in 31 countries. "This fully integrated company will meet multinational client demand and give our professionals the best possible platform to deliver solutions any place in the world," says James Didion, chairman and chief executive of CB Commercial. As to Richard Ellis' U.K. operations, there might be another deal in the future. "Our merger with REI Ltd. really creates opportunity for the U.K. company," Didion says, "and it would make sense from a number of perspectives - theirs and ours - for them to be part of this venture."

Another merger of real estate servicers included Goodman Segar Hogan Hoffler GVA of Norfolk, Va., and Atlanta-based Bryant Associates. The combined company will lease and manage 25 million sq. ft. in Washington, D.C., Virginia, North Carolina and Georgia.

While there were numerous deals among real estate servicers, the bulk of the consolidation in the industry occurred among owners and operators of property, particularly with the REITs.

There is a good reason for this. REITs were essentially created by the capital markets and, due to their unique structure, REITs are required to distribute 95% of taxable earnings which means they cannot retain earnings as other publicly traded companies do. So to expand, REITs continually need to develop, acquire or merge, which means they are dependent on the capital markets which, in turn, want to provide the capital necessary for the REITs to grow.

1997 was a strong transaction year, says Landauer's Kelly, and 1998 will be also because of the capital flowing into real estate.

It is a capital-driven market, says Greenwich's Milde. "There is a tremendous amount of money out there looking for attractive returns, and real estate investments provide that."

REITs break records in '97 The REIT industry raised a record $40 billion in 1997 and used the capital aggressively, acquiring properties in one-off deals, buying larger portfolios, merging with other REITs or absorbing private operating companies.

The future of real estate will include a significant segment that will be in public hands, observes Deloitte & Touche's Carlson, but there are still a lot of cross-currents. "A lot of portfolios out there are thinking about becoming REITs, or being acquired by REITs, and existing REITs are continuing to consolidate if for no other reason than the stock market seems to prefer larger REITs to smaller REITs due to their lower cost of capital."

In addition to the year-end Camden-Oasis deal, another late December purchase saw United Dominion Realty Trust Inc. buying ASR Investments Corp. of Tucson for about $134 million in stock.

Keeping track of REIT deals Included among the high-dollar deals in 1997 were Walden Residential taking on Drever Partners for $675 million, BRE acquiring the West Coast operations of Trammell Crow Residential for $600 million, Vornado Realty Trust and Crescent Real Estate Equities grabbing the cold storage operations of Americold Corp. and Logistics Inc. for $1 billion and Equity Residential moving in on Evans Withycombe Residential for $1 billion.

This doesn't even include the hotel REIT acquisitions, which were startling in number to say the least. Patriot American of Dallas went on a shopping spree, buying up California Jockey Club & Bay Meadows, Wyndham Hotels, Carnival Hotels, WHG Resorts & Casinos, Carefree Resorts and Interstate Hotels. Starwood Lodging of Phoenix, took about everything else including HEI, Flatley & Tara Hotels, Westin Hotels and ITT (which it snatched away from Hilton Hotels).

Among the other major hotel deals last year (some still pending) were Extended Stay America and Studio Plus, Marriott International and Renaissance, Sunstone and Kahler, CapStar and Winston Hospitality, Prime and Homegate, Promus and Doubletree, Signature and Marc Hotels, and Whitehall Ltd. Partnership and Chartwell Leisure.

"At some point, all the singles will be married," says Dieter Huckestein, executive vice president and president-Hotel Division of Beverly Hills, Calif.-based Hilton Hotels Corp. "But in the meantime, the consolidation wave clearly makes sense and will continue as long as suitors remain and the economics of the deals are compelling."

On the office front, the busiest dealmaker was Equity Office Properties of Chicago which inhaled Beacon Properties creating one of the largest capitalized REITs in the country. Meanwhile, Cali Realty Corp. and the Mack Co. also joined forces to created Mack-Cali.

"Size in itself is neither good nor bad, but being a larger company does create opportunity," says Mike Steele, executive vice president of Real Estate Operations at Equity. "Opportunity relates not just to the simple savings in operating expenses, but also to the cost of capital which begins to go down and the ability to provide a much broader array of services for tenants. Because of the large square footage base, one can move into areas that potentially other building owners don't have the chance or the wherewithal to explore."

In the industrial markets, one fast-moving company is First Industrial. In addition to its end-of-the-year dealmaking for Pacifica Holdings and Sealy & Co., First Industrial acquired three other companies in 1997. "We are heavily into the consolidation of the industrial sector," says Michael Tomasz, president and chief operating officer of First Industrial. "It is the largest form of commercial real estate in the United States, and it is also the least consolidated, only 1% to 1.5% is controlled by public companies. There is still so much opportunity in acquiring private companies."

The multifamily sector didn't see much in the way of major mergers; instead, the major deals were more in the line of big REITs buying up smaller private companies or large portfolios. "There have been some very large public mergers," says Jay Pauley, chief operating officer of BRE Properties in San Francisco, "but increasingly you are going to see a lot of public mergers with large private companies."

Going forward, Pauley adds, "it will be difficult in the future for REITs that have a market cap less than a half billion to effectively access the capital market. And, if you ask me the same question a year from now, I will probably say a billion. The cutoff rate keeps moving up. To get the investment grade rating so as to easily access both debt and equity, you are just going to have to be bigger."

Merger and acquisition activity in the real estate industry has been primarily marriages between like companies, reports Stan Ross, a managing partner with E&Y Kenneth Leventhal Real Estate Group in Los Angeles. "Look for further evolution to occur where 'connected' and fully integrated firms provide a range of services, domestically and abroad. These super real estate firms would likely include units such as an owner of real estate (probably a REIT format), a development arm (S corp, C corp or LLC), a pipeline company to acquire portfolios, a services firm, a finance entity and a unit operating overseas."

HOTELS Of all the real estate sectors, the lodging industry probably carries the weight of being the least settled. It was a year in which Starwood Lodging Trust, a company few people outside the REIT industry had ever heard of, took over ITT (Sheraton), a company everyone had heard of. There were so many deals, so many mergers, so many new players that one needed a scorecard to keep track of all the changes. This is not to say there wasn't a good reason for all this activity, the hotel industry has been on a roll since the mid-1980s, and now people want to cash in.

Hotels considered hot investment "The industry is incredibly active right now with the amount of cash available. The availability of capital is driving a number of mergers," says Robert Koger, president of Fairfax, Va.-based Molinaro Koger, a hotel brokerage company. He contends that the activity stems from the salubrious shape of the industry. "Prices for properties have increased every year since 1991, and this coincides with lower cap rates. The net effect of this is that properties are showing more net income upon which to capitalize. Owners are really benefiting from two aspects of the industry: bottom-line numbers and improving hotel markets."

Hotel values have increased from several points of view, says Stephen Rushmore, president and founder of HVS International, a Mineola, N.Y., appraisal and consulting firm. "Average room rates are increasing faster than inflation, and profits are increasing as well."

Hilton Hotels lost the epic battle for ITT to Starwood Lodging; however, that didn't diminish a fine year for the hotel chain including the introduction of a new brand, Hilton Garden Inn. "Thanks to a buoyant economy and strong demand, the hotel industry had a stellar year," says Huckestein.

The numbers prove Huckestein out. According to Smith Travel Research, projected RevPar in 1997 jumped to $48.38 from $45.71 in 1996, and average daily rates leaped to $74.43 from $70.09 in 1996. The industry's profitability has been on an upward march since 1992, surpassing $12 billion for the first time in 1996. The only blot was a slight dip in occupancy from 65.2% in 1996 to 65% in 1997. This was probably due to new construction. Busy builders included Hampton Inns, which added 16,652 rooms; Holiday Inn Express, up 13,100 rooms; Comfort Inn, 10,750 rooms; Extended Stay America, 8,606 rooms; and Fairfield Inn, 7,257 rooms.

Hotel construction picks up Coopers & Lybrand reports that construction has come back to near record levels with almost 160,000 room starts. Through the first half of 1997, the top markets for new construction were Las Vegas, Atlanta, Dallas, Houston and San Antonio. Also doing well were northern Michigan, Mississippi, southern Georgia, northern Ohio and Phoenix.

Some of these markets could see too much new product. "People have just flocked to the Phoenix area to build new product, and it is beginning to take its toll on the market," says Robert Rauch, director of Business Development for InterBank Brener Hospitality. "Overbuilding has clearly taken its toll on Texas. The markets there are clearly in trouble. In particular, San Antonio is dramatically overbuilt. Demand is not increasing to meet the supply."

The markets Rauch sees as doing very well include San Francisco, San Diego, Boston and New York.

In the next five years, Rushmore predicts, hotels in Chicago, New York, Anaheim, Calif., Los Angeles, Baltimore, Boston and Long Island will show the highest percentage gains in value. On the other hand, he says, care should be taken when investing in Austin, Nashville, Tenn., St. Louis, Albuquerque, N.M., Kansas City and Tucson, Ariz.

As to market segments, Rauch says limited service is definitely being overbuilt.

Rushmore claims pricing is better in the first-class and luxury sectors of the market. "I am still very bullish on first-class properties where there is little building taking place, while I'm concerned about economy and budget in certain markets. They are becoming rapidly overbuilt."

The market has shifted toward full-service being in larger demand than limited-service properties, says Koger. "A lot of construction occurred in the limited-service sector and, therefore, that segment of the industry is not perceived as very strong by Wall Street. The full-service segment has seen very little new construction and, as a result, capital is more readily available. That's where buyers are gravitating."

Caution should prevail in the industry, Rauch says, as occupancy is beginning to decline. Demand is growing by 2%, but supply is increasing by 3%. National occupancy has basically plateaued since 1995. There was a very slight percentage dip in 1997, and that trend line is expected to continue into 1998. In 1997, occupancy, as reported by Coopers & Lybrand, rose as high as 73.7% in the luxury market and fell to a low of 59.6% in the budget sector.

MULTIFAMILY This is a market that continues to perform well, appears stable, enjoys equilibrium but attracts few fans. Even those who operate here have turned to fingering their worry beads.

"I'm a little nervous," says Jack Goodman, vice president of research for the National Multi Housing Council in Washington, D.C. Earlier this year, Goodman wrote, "with apartment construction now at what appears to be a comfortable level, the challenge to investors and lenders alike is to keep it there. During the past two years, financing has been available for apartment development in greater amounts and on more attractive terms. Discipline and memories of the late 1980s and early 1990s may keep overbuilding from occurring this time around."

Concerns of overbuilding However, by the end of 1997, Goodman wasn't so confident. "We may be building a little too much. Construction figures in October and November were higher than the other three quarters. Those numbers are a little too rich. I'm cautious about where this market is heading."

Robert Johnson, 1997 president of National Apartment Association in Alexandria, Va., and president of the Pinnacle Cos. in Atlanta, also appears wary. "We should always remain cautious because in the climate we had for the past seven months -- where interest rates have been low, where the stock market has been bullish and inflation low -- it tends to promote a lot of development, and people think this development environment will stay rosy forever."

ERE Yarmouth's Emerging Trends In Real Estate: 1998 adds insult to injury by awarding apartments a "sell" recommendation, commenting that apartments were the first property sector to recover from the prior decade's recession and is "the first to flag as investor confidence wanes."

A check with the National Association of Real Estate Investment Trusts shows a middle-of-the-road performance for multifamily in 1997. Multifamily REITs checked in with a +8.2% performance in 1997. Better than retail and health care, but worse than industrial/office, hotel and equity REITs as a whole, the latter of which was up around 11.2%.

"It was a healthy year for the apartment industry," says Jonathan Kempner, president of the National Multi Housing Council in Washington, D.C. "Occupancy has been steady among the larger owners and managers, and people seem to be making money." Nevertheless, Kempner adds, "I am always concerned about the market being fickle. Nationally the apartment market is presently not oversupplied, but capital is quite liberal, and there is a concern that we don't overdue it." It's hard to say when multifamily peaked. Through the second quarter of 1997, occupancies climbed to roughly 95%, up from 92.5% back in the fourth quarter of 1992. A Deloitte & Touche report suggests 1997 will end up with an occupancy rate of 93.4% as absorption continues to lag completion.

Multifamily construction peaks Overall the peak of the construction cycle has already occurred but, if not, it should peak in 1998, suggests Larry Souza, director of research at BRE Properties. "Construction permits are running 260,500 this year as compared to 234,600 in 1996. There are definitely more units under construction in 1997."

Regionally, the South was strongest in 1997, but the West's growth will taper off compared to the year before. "Seattle and California are moving into the construction cycle," Souza says, "but Phoenix, Las Vegas and Denver are coming off the top of the cycle."

Even if the economy holds up in 1998, there should be some softening in the multifamily sector, but it will be very uneven, says Ronald Terwilliger, national managing partner for Trammell Crow Residential in Atlanta. He also expects good things from California and the rest of the Pacific Coast, steady performance from the Midwest, except for some cities such as Indianapolis, and mixed performance in Texas, with a weakening in Houston and a strengthening in Dallas.

Despite new construction, the sector was boosted by strong rents and pricing. The NMHC Market Trends newsletter in November reported rents at all rental housing rose 2.9% in the third quarter of 1997, matching the gain recorded in the second quarter. Meanwhile rents for apartments in large professionally managed portfolios tracked by M/PF Research of Dallas showed increases of 3.5% -- off slightly from the gains of the previous several quarters.

The best news was in pricing where Class-A apartment properties, as of the second quarter 1997, were selling for $77.59 per sq. ft., up a full 10.7% from prices paid a year earlier. The average cap rate on transactions was 8.8%, essentially unchanged since the second quarter of 1996. In New York, where most people own their apartments through condominium or cooperative arrangements, the average sale price of apartments hit $447,000, up 6.9% over the year before. "As 1997 draws to a close, this year has clearly erased any uncertainties surrounding Manhattan real estate -- the market has simply never been better," says Barbara Corcoran, chairman of the Corcoran Group in New York.

In New York, the market for luxury condominiums and cooperatives was very strong, and this appears to be the case for this class of rentals nationally as well.

"The most vibrant and active market for new multifamily construction is the luxury market," says Amy Dozier, NAA executive vice president. "This is primarily due to the aging of the baby boomers and their increasing incomes. There is definitely a trade-up market in rental homes just as there is in the single-family home market."

RETAIL Printed references to retail property markets usually contain the work "risk" somewhere in the text. It is a market with a lot of contradictions: aggressive expansions juxtaposed with weak fundamentals; people working in shopping center management and development love the opportunities, outside analysts are skeptical; and capitalization has been good, but investors are not overly fond of the sector.

Of the major REIT sectors, retail's performance for 1997 was one of the weakest. Shopping centers were up 12.6%, regional malls 4.4% and outlet centers off 12.6%.

ERE Yarmouth's Emerging Trends notes, "respondents again rank regional malls and then power centers last in virtually all investment categories." The publication reports mall rents are forecast to be flat for the year, with values increasing slightly, and that five-year and 10-year value changes trail those of all categories except the "moribund" power center group.

Retail properties showed weakness over the past two years as "cyclical strength in absorption evaporated while new construction picked up," says David Jacob, managing director and director of research at Nomura Securities in New York. The bottom, however, may finally have been reached, Jacob adds, "with all the risks and opportunities in a very competitive market."

A good summation of retail's performance comes from David Isola of the Greenwich Group, who notes in the company's booklet, Retail real estate: Marked up or marked down? that from 1992-96, total sales for the retail store industry increased by 7.2% per year on average. The increase in sales for the retail store sector was achieved despite a net reduction in the total number of retail stores. During the five-year period from 1992 to 1996, the net profit margin for this sector declined from 4% in 1992 to 2.9% in 1996.

Retail supply surpassing demand There is concern about the retail real estate market because overbuilding of shopping centers continues, says Raymond Torto, a principal with CB Commercial/Torto Wheaton Research in Boston. "Recent data show that the square footage of retail continues to grow in spite of the low returns in this sector."

Torto says the general trend line for new centers and expansion of old centers has been climbing for the past decade. A lot of new expansion product has come in the form of power centers. Of the 420 power centers across the country, 84% have been built over the past 14 years. Torto also says his most recent projections for the retail market nationally are for flat rental rates for the next five years as a result of oversupply.

Retail begins healthy trends Not so pessimistic is Marianne Waggoner, a senior vice president-managing officer for CB Commercial in Riverside, Calif. "Fueled by Wall Street, retailers have had a veryhealthy appetite and a huge growth demand. We are starting two important movements in 1997 that we expect to progress, one of them being an aggressive expansion mode by some retailers. We are also going to see consolidation and disposition of surplus property."

Other stronger trends include grocery-drug store combination expansion and stronger markets for retail and entertainment mix. Entertainment, particularly the vogue for multiplex theaters, can be a mixed blessing, says Emerging Trends: "No phenomenon better underscores the unsettled and dangerous retail landscape than the way retail owners latched onto movie theaters as a panacea. Five years ago, the goal was to have a 10- or 12-screen multiplex near a food court. Today these configurations are entirely obsolete. The new formula calls for stadium seating and 30 or more screens."

Not everyone is so down on retail. As noted, owners and managers of shopping centers take a much more optimistic view of their sector. Jensie Teague, managing director-Retail Development for Charlotte, N.C.-based Faison Associates, says retail properties maintain an occupancy of over 98% and have done extremely well. While there is just limited demand for big-box development, "there is a strong market demand for new neighborhood shopping centers."

Faison Associates mainly operates in the Southeast and, as Teague points out, Memphis, Tenn., Richmond, Va., Washington, D.C., Atlanta, all of Florida and the major cities in North Carolina are all experiencing strong retail demand. All major markets in Texas are doing well, although a slowdown in power center construction could affect overall development, reports The Weitzman Group, a Dallas-based real estate company. In the Dallas/Fort Worth metroplex, 2.6 million sq. ft. was added without affecting vacancies, and San Antonio wasn't much different, where 1.2 million sq. ft. was completed. In Houston, there's not much construction planned except for neighborhood shopping centers, says Dan Smith, a senior vice president of Houston-based Transwestern Property Co.

Further to the West, there has been a lot of construction in Phoenix, but absorption has been strong so vacancy rates are still above 90%. There is a shift now from power center to neighborhood shopping center development, says David Larcher, vice president of Vestar Development Co. in Phoenix., which has built seven power centers in the metro area. The scene is similar in Las Vegas. The city has been busy with retail construction, but rental rates have increased 30% over the past two years. The demand for goods and services has been "fantastic," says David Grant, vice president of Retail Properties at Henderson, Nev.-based American Nevada Corp., which is building two neighborhood shopping centers and has one more planned.

OFFICE "Remarkable!" says Hessam Nadji.

A record performance, adds CB Commercial.

What's all the buzz?

No, not a new Stephen Spielberg movie. Something more prosaic. The U.S. office market in 1997.

"The office market - a remarkable performance all the way around, especially led by the suburbs," says Nadji, a senior vice president and director of Research for Marcus & Millichap in San Francisco. "The comeback of the office market in general really surprised everyone. In 1992-93, people said office wouldn't come back for another seven to 10 years. Office recovered within five years."

Downtown office grows in strength In the third quarter 1997, downtown absorption totaled 10.8 million sq. ft., which equaled the amount for the first and second quarter combined, reports CB Commercial. "This is the largest amount of downtown space absorbed in a single quarter in the history of the CB Commercial Index (since 1986)."

The only blip on the screen for office is the possibility of a slowing economy in 1998 or another stock market collapse. "A stock market freefall that doesn't recover will have a major impact on the demand for office space in downtown markets, which are driven very directly by financial services," says Nadji. "Suburban markets should have a steady climb in the next two years because they are more dependent on the R&D-style tenant."

Suburbs continue to rule the market The suburbs have looked good for a number of years now, and CB Commercial reports the vacancy rate for those markets fell to 9.7%, the first time it has been in the single digits since the company started tracking suburban rates in 1984. The decline to single digits was fairly dramatic considering 10 years ago vacancies reached a peak of 23.4%. The lack of space in the suburbs has meant rapidly rising rents, forcing some companies to move back downtown.

1997 witnessed the continuing decline in availability of Class-A office space in both urban centers and suburban markets, attesting to the strength of a rebounding national real estate market, says Arthur Mirante, president and chief executive officer of Cushman & Wakefield. "For the past several years, demand for Class-A office space increased, demonstrating downtowns are on the rebound. Crime abated, years of budget tightening yielded budgetary surpluses and urban centered businesses such as financial services benefited from national economic expansion. These factors combined with virtually no new construction in the downtowns drove the increased demand for space."

The cities with the lowest CBD vacancy rates, reports Cushman & Wakefield, are: San Francisco, 4.5%; Bellevue, Wash., 4.8%; Boston, 5.3%; Seattle, 6.6%; and Portland, 7.1%. The areas with the lowest non-CBD vacancy rates include: San Francisco peninsula, 4%; Bellevue, 4.2%; San Jose, 5.8%; Portland, 6.6%; and northern Virginia, 6.6%.

A number of metro areas are still suffering from a glut of space. CBDs are a problem in Dallas (30.3% vacant), Westchester County, N.Y. (28.8%) and New Haven (23.4%), while the suburbs are difficult in Ontario, Calif. (24.6%) and Los Angeles (24%).

By in large, most metropolitan areas are doing better, and this has created a unique opportunity for new construction as there is a pent-up demand for office space where so few people can deliver, says Thomas Roberts, president of Opus West in Phoenix, one of five regional companies of the Opus Group. "There hasn't been any new office built in five years because the market was so bad, and now a lot of competitors are no longer in business."

Developers anticipate more work Those that have made it through the lean years can expect busy times ahead. Opus West, for example, is currently working on 1 million sq. ft. of space in the Phoenix area, 1 million sq. ft. in California and it has another 1 million sq. ft. on the drawing boards. Some of it is spec space, but most is at least 30% to 50% preleased. Most of Opus West's business is two- and three-story suburban offices.

The cities with the largest increase in office construction since 1994, reports Marcus & Millichap, are Atlanta, Raleigh-Durham, Dallas, Phoenix and Salt Lake City. The cities with the highest amount of construction as compared to current inventory include Las Vegas, Salt Lake City, Raleigh-Durham, Atlanta, San Jose and Phoenix. The areas with the lowest amount of construction as compared to existing inventory are Long Island, N.Y.; Hartford; Orange County; Stamford, Conn.; Newark, N.J.; and Houston.

"A wave of new speculative construction is unavoidable in suburban markets," Nadji says.

There are a number of people showing interest in development now, and there are a number of markets where business is expanding at a rate that really commands more product, says Equity Office's Steele. "Suffice to say, every major market across the country showed dramatic improvement in 1997 and, by all estimates, 1998 will be a repeat performance."

INDUSTRIAL "It was a very good year," says Henry "Greg" Gregory, president and chief executive officer Industrial Developments International.

IDI, an Atlanta development company that specializes in industrial properties, boasts assets of 12 million sq. ft. and has built more than 36 million sq. ft. of industrial space since the company was formed back in 1989. It was still building when 1997 closed, including a lot of speculative space.

Market sees stable spec development The industrial market has been so strong that it is one of the few sectors where speculative space has been constructed with any regularity. "We are building spec in all our markets," Gregory affirms. "There has been a pretty good balance between supply and demand, so we are comfortable building."

"The markets are really in terrific shape right now," adds First Industrial Realty's Tomasz. "There really isn't any overbuilding. Usually what causes problems in real estate is not demand but the supply getting out of kilter. It is not a situation that concerns us. There is spec building going on, but most of these markets are in the mid-90% range in terms of occupancy and probably needed some spec building."

When the dust finally settles, IDI expects 1997 to have been a record year in terms of profitability. However, 1998 could be vastly different. Gregory expects spec building will be cut back in some markets, the problem being too much capital flooding into the sector. "In all markets there is a good balance right now, but those markets favored by capital -- I emphasize we are a capital-driven industry not a demand-driven industry -- might well become overbuilt." He adds, big box continues to be popular so the first overbuilding will be in that product.

Other industrial boxes could be on the boom and bust cycle as well. As a direct reflection of booming high-tech industries, R&D/flex space has gone from saturation to scarcity in less than five years, Marcus & Millichap's Nadji notes. "While conditions for 1998 will improve further in this sector, significant devaluation of high-tech stocks or a steep decline in venture capital flows could dampen demand rapidly."

"Industrial is one of the healthiest product types," Nadji says. "Construction rebounded a couple of years ago when the economy started to take off and we saw the return of warehouse and standard industrial properties."

SIOR reports the national industrial vacancy rate as of the third quarter 1997 was 7.1%, the same as the year before.

CB Commercial, which looks at large industrial buildings (over 100,000 sq. ft.) in the major metro areas, reports a vacancy rate of 8.2%, up from 8% the year before. The cities with the lowest industrial vacancy rates, according to CB Commercial, are: Oklahoma City with 1.2%; St. Louis, 3.5%; Cincinnati, 4.3%; Detroit, 4.3%; and Houston, 5.1%. At the other end of the scale, the cities with the highest industrial vacancy rates were Palm Beach, 17.4%; Las Vegas, 16.7%; Washington, D.C., 16.4%; Baltimore, 16.3%; and Orlando, 16.1%.

A Deloitte & Touche report shows in the years 1993-1995, absorption in industrial managed to stay ahead of advancing completions but, in 1996, completions jumped to 90 million sq. ft., which was more than the space absorbed that year. The same thing occurred in 1997 where about 110 million sq. ft. of space was built, but only about 100 million sq. ft. absorbed.

There are some clouds on the horizon for industrial. Despite all the new construction, rental rates haven't declined yet. Deloitte & Touche did note that rents have begun to plateau and the price increases of industrial buildings per sq. ft. moderated as well. Even though markets added inventory to this sector, rents and values are now increasing slowly, says Deloitte & Touche's Carlson. "The increases in both have only been between 2% and 3% this year."

In addition, the economic turmoil in Asia could affect development and absorption of industrial property, especially on the West Coast, suggests Tomasz. "Even a little slow down in the U.S. economy could result in a slowdown of industrial absorption."

* American General Hospitality Corp. bought 14 hotels for $270 million from Financial Security Assurance; * Boston Properties took a portfolio of nine buildings, valued at $139.6 million, from Mulligan/Griffin Associates; * First Industrial Realty Trust paid $138 million for operations of closely held Sealy & Co. and $200 million for 106 properties from Pacifica Holding Co.; * Simon DeBartolo Group and Macerich Co. formed a joint venture to buy 12 regional malls for $489.5 million and the assumption of $485 million of debt; * Walden Residential takes on Drever Partners for $675 million; * BRE acquires the West Coast operations of Trammell Crow Residential for $600 million; * Vornado Realty Trust and Crescent Real Estate Equities grabbed the cold storage operations of Americold Corp. and Logistics Inc. for $1 billion; * Equity Residential moved in on Evans Withycombe Residential for $1 billion.

* Projected RevPar in 1997 jumped to $48.38 from $45.71 in 1996. * Average daily rates leaped to $74.43 from $70.09 in 1996. * Industry's profitability surpassed $12 billion for the first time in 1996. * There was a slight dip in occupancy from 65.2% in 1996 to 65% in 1997.

* Multifamily REITs show a +8.2% performance for the year. * Occupancies climbed to roughly 95%. * Approximately 260,500 construction permits issued in 1997, compared to 234,600 in 1996. * Rentals at all rental housing rose 2.9% in the third quarter of 1997, while apartments in large professionally managed portfolios increased 3.5%. * Class-A apartment properties, as of the second quarter 1997, were selling for $77.59 per sq. ft., up 10.7% from a year earlier. * The average cap rate on transactions was 8.8%, essentially unchaged since the second quarter of 1996.

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