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Commercial Space Still in a Bind

Analysts say office glut will stymie construction for years, though retail space fares better

CONSIDER the plight of 116 Huntington Avenue, completed in 1991.

The architecturally acclaimed office building in Boston's Back Bay is still only 45-percent occupied. The same story is heard in big cities nationwide, though the market for downtown office space in Boston is stronger than in most cities.

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The downsizing of large American corporations and the rapid growth of small start-up companies is bringing a fundamental change in commercial real estate. Big companies that lease downtown real estate have seen the sharpest and most-permanent trims in their payrolls.

"As long as you don't have growth in those kinds of [middle-management] jobs, nobody's going to need the kind of office space they have in the past," says David Runkle, a senior economist with the Federal Reserve Bank of Minneapolis. Heading for the suburbs

The move to smaller companies is being accompanied by a shift out of town. "Small businesses generally start out with very small space requirements," says Hugh Kelly of Landauer Real Estate Counselors. "Suburban buildings fit that profile better than central-city office buildings that are generally laid out with a bigger tenant in mind," Mr. Kelly says.

Many analysts estimate that significant new construction of commercial space will not begin until near the end of the decade.

"Contracting for office buildings is still declining," says Michael Montgomery, a senior associate at DRI/McGraw-Hill in Lexington, Mass. He predicts that the office and industrial real estate sectors will not bottom out this year.

Kemper Securities Inc. predicts that commercial real estate will bottom in 1994.

Landauer Associates reports that 575 million square feet of office space are vacant in the US. The real estate services firm predicts that about half of the real estate now vacant will be absorbed in the next five years. Absorption of space will bring national vacancy rates now at about 19 percent down to the single digits, Kelly says. "Some construction activity will be justified in the last couple of years of the decade."

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Demand for office space has also been curbed by a slowing of the number of women entering the work force. The Census Bureau and the US Department of Commerce report that in 1991, the percentage of women working dropped for the first time since 1975.

One glimmer of hope in the commercial area is the retailing sector, which responds more quickly to improving business conditions. Some analysts predict that retail rents will start rising 8 to 10 percent per year. According to Sumichrast Reports, a real estate newsletter, retail construction through last October increased 14.5 percent over 1991.

"A combination of the economy turning around and retail sales picking up will help," says Mr. Montgomery. He points to "new-concept" stores such as extra-large supermarkets, warehouse outlet stores, and expanding chains such as Wal-Mart as a source of growth. "Generally when they move into an area they don't buy existing buildings.... They are not big enough," Montgomery says.

Landauer's Kelly is less optimistic about retailing: "Only when we have another year or so of job creation under our belt will consumers have the confidence that will allow them to resume spending."

"Nobody is predicting that we are going to have a huge boom," says Runkle of the Minneapolis Fed. Overbuilt market

Houston is a good example of how far the office market has to go. Though the vacancy rate has been improving, it still stands at about 20 percent. Texas is one of the leaders in the nation's economic rebound. "In terms of job generation, Texas is performing well," Kelly says. "Houston will benefit from providing services for companies looking toward taking advantage of the North American Free Trade Agreement." Analysts predict that working out from under the overhang of debt-ridden office space will take

several years. Until then, rents will be flat, and little building will occur.

Hotel real estate still faces a crunch. Landauer Associates reports that consumer demand for hotel rooms is only slowly catching up with supply. Too many rooms stay empty every night for these properties to be profitable investments, but most operators are holding out for a recovery. Landauer predicts that room rates and occupancy will rise slightly this year. Many foreclosed hotel properties are being put on the market for prices that are approximately half their replacement cost, according to KPMG Peat

Marwick, the accounting firm.

Though factory closings by large firms have hurt industrial real estate badly, the Bureau of Labor Statistics finds the number of small factories opening on the rise.

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