Cycles & Comparisons : Kondratieff's Theory Holds That Long-Term Expansion, Contraction Governs Construction of Capital Plant.

By RUTH RYON

April 6, 1986 12 AM PT

Times Staff Writer

Halley’s Comet is like the commercial/industrial real estate market.

Like grasshopper plagues, poets’ creativity, the melting of glaciers. Even political landslides and the number of infants born each day.

All fluctuate in cycles.

Trouble is: Cycles are not exact. As Fred Case, a UCLA professor, observed: “Nobody seems to be able to precisely forecast a turn of events.”

Jay W. Forrester, a professor at the Massachusetts Institute of Technology, in a telephone interview, cited the Kondratieff, or Long-Wave, Theory as evidence that another major recession might occur within the next three years. Kondratieff, a Russian economist of the 1920s, suggested what Forrester described as “an orderly proceeding” that led to depressions in 1830, the 1890s, and--after Kondratieff’s time--in the 1930s.

The Kondratieff Theory “consists of major expansions and contractions in construction of capital plant, with related changes in debt, prices and interest rates,” Forrester wrote in a paper on the subject. By contrast, he defined “ordinary business cycles” as having “peaks, some three to seven years apart.” So how deep a recession does he predict? “Well, you know that the farmers are already in one as severe as the 1930s,” he said. As for real estate? “Every recession since 1960 has been more severe than the one before, so I expect the next two recessions to be even more severe.”

Forrester agrees that a major recession cannot be predicted with precision. “After all,” he says, “we’re talking about recessions 45 to 60 years apart.”

Shorter cycles haven’t been forecast exactly, at least on a regular basis in recent years, either, and Al Gobar, who heads a Brea real estate consulting firm, explained why:

There is a seven-year commercial-construction cycle, but there is “nothing mystical about it,” he said. “It takes 3 1/2 years to get overbuilt and 3 1/2 years to start building again.”

But are the numbers precise? “Hell no,” he answered. “You must look at causes and effects. Otherwise, it’s like saying, ‘It’s good that you have ears, because then you have a place to hang your glasses.’ ”

Like the rainstorms and high surf that signaled the possible return to Southern California earlier last month of El Nino (the warm ocean current that disrupted weather patterns all over the world three years ago), there are several warning signs of a potential downturn for commercial and industrial real estate developers.

In many U. S metropolitan areas, including Los Angeles, there already is an abundance of office space. In many places, there are too many hotels. In some, strip shopping centers have replaced gas stations on every corner. And the industrial market, especially research-and-development office space in some locales, is almost as bad.

The situation isn’t the same everywhere. As Walter Silber of Brentwood Financial Corp., a West Los Angeles-headquartered real estate syndication company, put it, “Cycles vary from one locale to another.”

Small shopping centers are overbuilt in some places, but his firm is expanding one in Atlanta, and he is looking at the small shopping-center market in Portland, Ore., where he says, “it’s an idea whose time has not yet come.”

Also, consider New York, where office vacancies are surprisingly low for a large city. Developer Donald Trump’s engineering staff is completing plans for a 150-story skyscraper in Manhattan. That’s 40 stories higher than the current leader, Chicago’s Sears Tower. (This coming July’s issue of Popular Mechanics will also relate plans for a 210-story Chicago World Trade Center and a proposed 500-story tower.)

So, the short-term construction cycle can vary according to project type and geographical location, but it generally works the same. C. Wesley Poulson, who retired last summer as head of Coldwell Banker and has since formed a new investment group, said, “As long as we have a free economy, we’ll have these swings of the pendulum.”

Asked why the swings in construction seem to be so radical, William Harvey, senior vice president of Wells Fargo Realty Finance in Santa Monica, said, “There is overreaction. First comes concern that a market is overbuilt. So then an underbuilt situation is created.”

Andrew Kane, a partner in the Los Angeles office of Arthur Andersen & Co., a certified public accounting firm, put it simply: “The bottom line is supply and demand. It’s a function of economics.”

Gobar explained how the construction cycle works:

“You overbuild, then lenders stop making loans, construction stops, rents go up, there are no vacancies, and building resumes. A couple projects are built, then a couple more. Then lenders make loans willy nilly. Projects get bigger and bigger before things hit the fan. It’s easy to get this started, hard to get it stopped.”

Developers, described by some developers as “opportunistic” and others as “entrepreneurs with lots of--maybe, at times, too much--confidence,” will build as long as they get the financing.

Robert M. Holmes, chairman of the board of Oltmans Construction in Whittier (a developer of industrial and low- and mid-rise office space) added: “Many developers will continue to build beyond demand because it is a cyclical business. Eventually, the space gets absorbed. Sometimes it takes two years, but it happens.”

Lenders often continue lending even after there is an oversupply, because they do not know that a market is overbuilt, according to Gobar. Why don’t they know? “Because nobody does a good job of collecting data, and there is no incentive for a developer to complain to a banker.”

Then there is the time that it takes to get a structure, especially a high-rise office building, built. Christopher Martin, a partner in the 80-year-old Los Angeles architectural firm Albert C. Martin & Associates, recalled that it took 18 months for the Los Angeles City Hall, which his grandfather designed with John Parkinson and John Austin, to be completed in 1927.

“Now it takes seven years from the time we are hired to design a downtown office building until it is occupied,” he noted.

And who knows what the market will really be like in seven years? Nobody. So, as Hayden C. Eaves III, general partner and manager of the Los Angeles office of Trammell Crow Co., observed: “Who can best afford to gamble on long-range marketability? Some pretty deep-pocket players.”

Or as Case warned, “Do not go into any high-risk real estate project unless you can afford a big loss.”

Trammell Crow claims to be the nation’s largest privately held commercial/industrial real estate development company, but Eaves considers himself “risk adverse. I minimize risk,” he explained.

He has spent the past 13 years on a project to redevelop much of the City of Commerce, turning land use from heavy manufacturing to business parks. Trammell Crow builds to keep, so during downturns, it simply manages what it has. “You can be a submarine or a ship, which can float on top if there’s a storm,” he said.

Many developers already have sunk into bankruptcy, and others have filed during the past few weeks. Eaves sees one of the challenges of banks today as their REO (real estate owned) departments.

“Lenders turn off the faucet. The money dries up. Credit is not there. And the bank ends up owning the high-rise office building, for example, that they underwrote five years ago.”

Out of this comes a phenomenon known as “grave dancing” and opportunity.

As Los Angeles developer Wayne Ratkovich pointed out: “Somebody has to deal with the assets that are taken back. A bank that has trouble with one developer simply calls in another to do something about it.”

Better to avoid the problem in the first place, he concedes, saying: “Wise developers will try to anticipate cycles, judge timing and not build in an oversupplied market.”

He is taking his own advice. He put his plans to build offices and residential units behind the Wiltern Theatre, which his firm bought and renovated, on hold, waiting, he says, “until the market is right.”

Some Los Angeles builders and developers see an oversupply in many places in the Southland for the next two years. Ben Bartolotto of the Burbank-based Construction Industry Research Board says that anticipation of tax reform increased the level of non-residential construction in California last year.

It totaled a record $13.2 billion, but he expects a slowing in office, store and hotel building this year. As tax specialist Kane observed: “Real estate is a tax-driven industry. It is very tax sensitive.”

The overbuilt situation in many markets will probably stimulate developer interest in preservation, Ratkovich said. “And developers will work more diligently to see that their products are pre-leased. They will act more as investors than developers. And they will shift to the strong, economically healthy market areas, like Los Angeles, instead of Houston.”

Even in downtown Los Angeles, where there is a high vacancy rate, office buildings are still being built. This doesn’t concern architect Martin, whose firm is designing several.

Los Angeles is unusual, he says, because it got its first high-rise, the 36-story Union Bank Building (which his firm designed), in the mid-1960s. So he looks at Los Angeles as a new, major metropolitan area, still attracting large corporations and foreign investors. Besides, it has a diverse economy, he notes, unlike oil-dependent Denver and Houston. “Yes, vacancies are a little high,” he admitted, “but I don’t think they’re dangerous, because the ability to absorb space is certainly there.”

Houston and Denver, beset by oil and energy-related setbacks, are suffering in the current economy.

For some years, the bustling Texas city enjoyed a building boom and became a national leader in commercial and residential construction. Its builders and developers had “deep pockets,” they boasted. But when the world oil prices plummeted, its troubles began. In real estate jargon, Houston became a “see-through city” because it had so many empty buildings.

Denver, too, is suffering from oil and energy-related problems, perhaps less than its Texas counterpart. But the economy of both cities is very closedly related to those major busineses, unlike Los Angeles.

Builder Holmes isn’t discouraged, either, saying, “California is still and will continue to be the oasis in the desert of construction.”

Or, as professor Case observed: “The California real estate market is like Chicago weather. If you don’t like it, wait, and it will change.”

Just when is uncertain, but that it will is as predictable as Halley’s Comet.