It started as a few isolated cases. Then, slowly, almost imperceptibly, it spread across the country. Into apartments. Stores. Warehouses. Hotels. And now, offices. It may be in your very building.

What is it? The real estate recovery. After many fits and starts, the battered industry is finally on the rebound and picking up momentum. "The only thing holding the market back right now is the memory of the past five years, when people got badly burned," says Mark Zandi, chief economist at Regional Financial Associates Inc. (RFA) in West Chester, Pa.

The economic expansion gets a lot of the credit for helping shrink the industry's huge inventory of unused office space. Vacancy rates, though still high, are dropping in most office markets across the country. In some areas, rents are even rising, and hefty concession packages are no longer necessary to hook tenants. Indeed, in a few markets, ground is being broken for new office construction without even signing up tenants beforehand. And after years of being a drag or having little impact on the gross domestic product, commercial construction is picking up speed and actually adding to GDP growth. At $164.4 billion, real spending on commercial structures is up more than 9% in 1995, compared with 2% growth in 1994 and drops in spending from 1991 to 1993, according to figures from RFA and the Bureau of Economic Analysis.

The most visible sign that the office sector is headed for better times is the battle for control over one of the world's premier office properties, the Rockefeller Center complex in midtown Manhattan. Rockefeller Center Properties Inc., (RCPI), the real estate investment trust that holds the center's $1.3 billion mortgage, saw the major owner of the property, Japan's Mitsubishi Estate Co., file for bankruptcy in May. Now, despite the loss of its interest stream from the mortgage, savvy investors are flocking to RCPI's doors. The draw: cutting a deal with RCPI that could eventually lead to an ownership stake in Rockefeller Center properties.

Two of the latest players trying to buy into RCPI are Chicago-based real estate magnate Sam Zell and New York developer Jerry Speyer. Zell says that top-flight office buildings are the best investment opportunity in real estate today. He expects such properties to improve steadily for the next 4 to 5 years and doesn't expect much new development for 3 to 4 years.

While midtown Manhattan is a hot spot, with vacancy rates from real estate firm Cushman & Wakefield showing a drop from 15.1% to 13.1% in the past year, the outlook for the downtown business district around Wall Street is gloomy. Granted, vacancy rates there dropped to 18.7% in 1995's first quarter, down from 19.4% in 1994's first quarter. But as companies relocate to the suburbs in search of more modern space and a better quality of life, the Wall Street area and other downtowns are suffering. That trend is reflected in the national vacancy rate for central business districts (CBDs), which, at 16.7%, is virtually unchanged from the prior year.

There are exceptions: Atlanta's CBD vacancy rate slid from 22.6% to 17.3%, helped by pre-Olympics leasing activity. A growing financial services sector in Boston helped vacancies in that downtown market drop from 13.4% in 1994's first quarter to 11.1% in 1995's first quarter. But some areas, such as Dallas and Houston, which suffered from massive overbuilding, still look doggy.

COLD CASH. The suburbs are another story. Even while downtown Dallas saw a sharp rise in its vacancy rate over the past year--from 33.5% to 37.2%--suburban Dallas' rate slid from 21.3% to 16.6%. Other suburban markets that had steep declines include Seattle, which saw vacancies drop from 27.7% in 1994 to 18.8% in the first quarter of 1995, and Chicago, where the suburban rate fell from 18.6% to 15.4%.

Landlords in strong markets such as Charlotte, Raleigh-Durham, Atlanta, and Las Vegas have even been hiking their rents. And the increases are coming in cold, hard cash. In many other parts of the country, the gain comes in a reduced need to entice tenants with a month or more of free rent or improvements to space. Concessions such as free rent have virtually disappeared in Boston's suburban and downtown office markets.

In some markets, demand is so high that new construction is just around the corner. Peter Goodell, director of real estate valuation and counseling at Coopers & Lybrand, points to Phoenix, Denver, northern Virginia, and Washington, D.C. as areas where the income from rents is reaching a point where new development is close to becoming feasible. Development is already under way in Atlanta's Alpharetta suburb, where real estate company Cousins Properties Inc. is building a six-story office building with 126,700 rentable square feet "on spec"--before even lining up tenants. And the first speculative office building to break ground in the Los Angeles area since 1990 is in the works in the Tri-Cities area, where the entertainment industry is riding high.

New construction is booming in the industrial sector of the real estate market--factories and warehouses. Here, the technology industry is fueling much of the growth. The sector is benefiting from the need of high-tech manufacturers to expand into state-of-the-art facilities. Industrial vacancy rates have dropped to 7.4%, a 30% decline from a year ago, notes Michael Evans, national director, E&Y Kenneth Leventhal Real Estate Group. Zandi says that more than 50% of the increase in the sector over the past year comes from high-tech activities.

Another area where demand is starting to outstrip supply is in the apartment sector. Vacancy rates of 3% to 4% are not uncommon, and market rents are growing faster than inflation. The outlook is not nearly as bright for retail properties, such as shopping centers, however. When growth in retail shopping center space is divided by a population estimate, the result shows retail space per person growing at a compound annual rate of 2.4% from 1988 through 1994, according to the International Council of Shopping Centers. Use the same population figures to get the increase in real retail sales, however, and growth is just 1.5%, says S. Michael Giliberto, director of Lehman Brothers Inc.'s commercial property research team. Overbuilding in retail is actually worse than in office, says M. Leanne Lachman, of Schroder Real Estate Associates in Manhattan.

NEW RULES? The key to whether real estate experiences another boom-bust cycle lies in how much development capital flows back into the industry. Banks are likely to start lending again, but Zell thinks that there will be stricter standards for construction loans and that the days of virtually all-debt deals are over. Rents have been beaten down so much that borrowers would have to show that rents on new projects would double by the completion of the project just to justify the deal, says Zell, adding that "even lenders aren't that stupid." Another check on the industry is the more stringent regulatory environment. "Today, we have risk-based capital rules, and enforcement is a lot stricter," says Leonard G. Sahling, Merrill Lynch & Co.'s real estate economist.

Will it really be different this time? After each boom-to-bust real estate cycle, bankers, investors, and developers have sworn that they've learned their lesson. But somehow, the promise of fat returns has a way of short-circuiting memories.

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