Real Estate: Room at the Top, Bottom, and Middle

In commercial real estate, vacancies are up, and rents down

Last year, DigitalWork Inc. signed a lease for 140,000 square feet of office space in the heart of Chicago's financial district. But after canceling its initial public offering and firing 25% of its workers, the Internet startup is still in its original office a few blocks away. As for the building it planned to call home--well, it's one-third full, with not a single dot-com among the tenants.

DigitalWork's retreat is a familiar one these days, and not just among tech newbies. After a decade-long boom that sent rents soaring, commercial real estate is slumping as the rapidly shrinking economy leads businesses to bail out of leases and shelve office expansions. Vacancy rates are lurching higher, and rents are falling from Boston to San Diego. Frenzied bidding wars among would-be tenants, common just a year ago, are no more. "The froth has come off," declares Timothy H. Callahan, president and chief executive of Equity Office Properties Trust, the nation's biggest office owner.

E-VICTIONS. The reversal is sharpest where the tech frenzy had been greatest. Rents have dropped 25% in the past few months in Silicon Valley. Even so, the number of leases signed there so far in 2001 is 75% less than a year earlier, estimates Roger A. Gage, a Cushman Realty Corp. senior vice-president. In San Francisco's South of Market district--where tech companies once replicated like an Internet virus--rents have plunged by 40% since late 2000.

The same draft is blowing elsewhere. In Seattle, some 1.8 million square feet of space is available for sublease from high-tech tenants, up from 800,000 sq. ft. in December, figures Gregory J. Whyte, a Morgan Stanley Dean Witter analyst. West Los Angeles also has about 1 million sq. ft. of empty office space. And in New York's Silicon Alley, rents have skidded 30% since last fall.

Downtown and suburban markets alike are smarting. "For sale" signs that went up in early 2000 are still hanging on two big towers in central Philadelphia. Chicago is adding so much space that developers fear its vacancy rate could hit double digits by yearend. And while vacancy rates in midtown Manhattan remain near a 20-year low, at less than 3%, rents in new buildings have slipped 5% since last fall. They're dropping even faster in Westchester County, N.Y., and New Jersey. Prices are going to "soften a little more," says Jacque Ducharme, president of Julien J. Studley Inc., which represents corporate tenants.

The slide is great news for tenants. Interwoven Inc. CEO Martin W. Brauns began hunting for 200,000 sq. ft. in a single building in Silicon Valley a year ago but got priced out of the market, as rents jumped to $85 per sq. ft. Now, the software company plans to sign a lease at $55 a sq. ft. "It's turning to a renter's market," notes Brauns.

RESTRAINT. The downturn may also spark consolidation in the real estate business. Just look at Equity Office's Feb. 23 deal to buy Spieker Properties Inc., a Menlo Park (Calif.) landlord that's big in the Bay Area, for $7.2 billion. Analysts called the price low, suggesting that Spieker rushed to sign. Chairman Warren E. Spieker Jr. says he only wanted to broaden his holdings, while Callahan says in the long term, Spieker's properties are winners.

Still, no one predicts a bust like the one a decade ago that left skyscrapers sitting empty. This time around, lenders required developers to sign up more tenants and put up more of their own money before agreeing to finance a project. This restraint has, for the most part, prevented overbuilding of offices except in markets such as Chicago and Dallas. And it means that banks have much less exposure. In Washington, for example, developers have "preleased" more than half the space under construction, says Ducharme. "The commercial real estate markets are still very healthy," insists Maria Sicola, a senior managing director at Cushman & Wakefield Inc. Maybe, but the boom days are looking as long ago as when the Nasdaq was at 5,000.

By Michael Arndt in Chicago, with bureau reports

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