The Manhattan office market in 1995 gave the real estate industry another lesson in humility. The year began with landlords, developers and brokers riding the crest of a wave of healthy leasing activity and absorption. Owners were increasing rents, investors were bidding up building prices and developer Howard Ronson was poised to begin the first speculative office project of the 1990s at 383 Madison Ave.

But by the middle of 1995, the market was clearly running out of steam. Leasing activity and absorption in the first half was down in all three of the city's submarkets: midtown, downtown and midtown south. Some landlords who had over-reacted to 1994's encouraging statistics were being forced to retreat a bit from the rent hikes they implemented. Slow pre-leasing prevented Mr. Ronson from taking title on his site in June as he had planned. Instead, he renewed his option to acquire it.

"The market's taking a breather from where it started the year," says Michael T. Cohen, president of Williams Real Estate Co.

To be sure, no one was predicting another market collapse like the one of the late-1980s that devastated, and permanently altered, the city's real estate industry. Despite the market slowdown, several positive trends emerged in 1995. Expansions by entertainment and media companies like Viacom International and News America Corp. reinforced New York's role as a central location in that burgeoning industry. The city also seemed poised to play a lead role in the software industry, as a growing number of firms chose to start-up and relocate to New York to be close to its mother lode of creative talent.

Bruce Mosler, vice chairman of Galbreath Co., points out that technology companies also are recognizing that it pays to be in an international city. "If you look at software firms, you will see that overseas business is increasingly becoming an important part of their bottom lines," he says.

Moreover, several government policies and programs were having a positive impact on business growth. After years of delay, the state and city finally announced this year a finalized deal with Disney Co. that will allow a major redevelopment of 42nd Street to begin. The private sector also reacted favorably to Mayor Rudy Giuliani's program of downsizing city government and cutting taxes.

But for every two steps forward the market took in 1995, it took one step backward. Even as new businesses like software development expanded, more established companies contracted or even relocated out of the city. While investors maintained a healthy appetite for Manhattan office buildings, some owners continued to struggle with properties that accumulated too much debt in the 1980s. The most dramatic example of this was Rockefeller Group Inc., which was forced to file a bankruptcy petition for the world-famous Rockefeller Center complex. More than any other single event, that action reminded the real estate industry that the Manhattan market's recovery had a long way to go.

Economic statistics indicate that the market in the next few years can expect more of the same. The number of people working in the city rose to 3.3 million in 1995, a pickup of some 30,000 jobs from its post-stock market crash low in 1993. But the city's Office of Management and Budget projects that employment in 1999 will have risen only to 3.4 million. That's still more than 200,000 fewer workers than in 1989.

"In 1994, there was a sense that we hit the worst and things would start booming again," says George N. Georgitseas, president of Anderson Organization Inc. "Now the view is that the economy is coming back, but slowly, with stops and starts."

With the economy uncertain, brokers report that the majority of tenants are still tentative about expanding. The financial services industry, which in the past has been the engine of the city's economy, has shown little appetite for new space even with the stock market hitting new records. Other tenants are postponing making decisions until the last minute and then only taking what they need, says Mr. Mosler. "Tenants in the marketplace today are being cautious," he says. "If they take expansion space, it's usually with an option."

Real estate professionals were more optimistic in 1994 for good reason. Williams reported that strong leasing activity absorbed 3.9 million sq. ft. in midtown and 1.3 million sq. ft. downtown, compared with 1.3 million and negative 2.8 million respectively in 1993. Absorption was negative in midtown south in 1994, to the tune of 236,000 sq. ft., but only because Metropolitan Life Insurance Co. vacated its 1.9 million square foot tower at 11 Madison Ave., according to Williams.

On the other hand, market statistics show clear evidence of a slowdown in 1995. In the first six months of the year, tenants leased 10.6 million sq. ft., compared with 12 million in the same time period in 1994, according to Edward S. Gordon Co. The trend in absorption was even more alarming. That statistic was a negative 1. 1 minion in the first half of 1995 compared with a positive 2.2 million in 1994.

Of Manhattan's three submarkets, midtown south has been the only one to enjoy positive absorption in 1995, some 284,000 sq. ft. on leasing activity of 1.4 million sq. ft. And that statistic does not include the lease of 1.1 million sq. ft. in 11 Madison by CS First Boston Corp., which finally closed in late July. That deal should not only push the submarket's vacancy rate into single digits, it should also change the area's character and broaden its appeal.

Until the CS First Boston deal, midtown south primarily attracted firms in such fields as architecture and advertising which liked its lower rents and more casual atmosphere. But brokers predict that the move of the white-shoe investment bank to the area will change that.

Brokers are less sanguine about demand intensifying in midtown, which in 1994 was the darling of the real estate industry. Tenants leased 8.2 million sq. ft. in the first half of that year, but in the first half of 1995 that figure dropped to 6.9 million sq. ft., according to Edward S. Gordon. Absorption for the first half of 1995 was negative 211,000 sq. ft. compared with positive 1.1 million sq. ft. for the same period in 1994.

The decline in absorption also has been a product of tenants returning large blocks of space to the midtown market. CS First Boston's move to midtown south will vacate 500,000 sq. ft. at 55 East 51st St. and 100,000 sq. ft. at 12 East 49th St. Mastercard International's decision to move to Westchester County has made available 210,000 sq. ft. in 888 Seventh Ave. PaineWebber Inc.'s acquisition of Kidder Peabody & Co. opened up a 320,000-square-foot block in 1251 Sixth Ave.

Landlords and brokers expect this trend to continue for the remainder of the 1990s, acting as a counter-balance to increases in demand. Indeed, Bankers Trust Co. has announced that it plans to sell or lease most of the space in its two-building complex at 280 Park Ave. That will put another 600,000 sq. ft. of prime space on the market.

Michael R. Laginestra, an executive managing director at Edward S. Gordon points out that several large publishing companies have leases expiring in midtown in the late 1990s. If the past is any guide, he predicts that many will recognize that they could cut their expenses significantly by moving jobs out of high cost space. "If you're a publishing company that has a division in $45 a square foot space that can be moved to Brooklyn or New Jersey where space is $25 a square foot, you have an interesting decision to make," Mr. Laginestra says.

The failure of rents to rise significantly has been the primary obstacle to new development. But real estate professionals say that only the nicest floors in the most prestigious, well-located buildings in midtown have been able to achieve that amount. Tenants signing deals at Class-A properties like 320 Park Ave. and 590 Madison Ave. have been paying rents in the $40 to $45 per square foot range, brokers say. "There's virtually no market above $45 per square foot," says Mr. Cohen, of Williams.

But that is not necessarily a deterrent to forward-looking developers. For example, the Durst Organization has been actively seeking sources of debt and equity investors for the 1.5-million-sq.-ft. development on 42nd Street between Sixth and Seventh avenues. Douglas Durst, a vice president in the organization, says he is confident of success partly because his company already has raised $75 million for the project by refinancing three of its midtown properties.

Mr. Durst says his project also must be able to fetch $50 rents, but he predicts that the market will be well above that in 1999 when the building would be finished. "There's been no new construction since 1989," he points out. "The new building market has a zero vacancy."

In downtown Manhattan the issue has not been when speculative development will resume. It's been about survival. Hurt by continual relocations and the anemic demand by the securities industry for new space, that submarket has lagged the two others throughout the late-1980s and early- 1990s. Leasing activity in the first six months of 1995 was only 100,000 sq. ft. below 1994's 2.3 million sq. ft. But because of downsizings and relocations, absorption was negative 1.2 minion sq. ft., compared with negative 15,000 in the first half of 1994. The market, whose overall vacancy rate hit a new high of 24.6 percent in June, was particularly hurt by moves to midtown by such tenants as Donaldson Lufkin Jenrette Securities Inc. and the law firm Winston & Strawn.

Making matters worse, more relocations and downsizings are looming on the horizon. Merger and acquisition activity in the insurance industry, affecting such companies as Continental Insurance Co. and Home Holdings Inc., are threatening to dump as much as 1 million sq. ft. on the market.

Ironically, Mayor Giuliani's solution to downtown's plight temporarily added to the problem. The administration proposed a broad program of tax breaks and zoning changes to revitalize lower Manhattan. But that plan became the victim of political maneuvering and has taken longer than expected to get state legislative approval. Although most industry officials predict that it will be passed in a special session in 1995, many tenants have continued to postpone signing leases until it became finalized. "People want to see in black and white that they're going to be eligible for the benefits in the plan before they go ahead and sign and find out it's not retroactive," says George T. Rossi, an assistant director of the Port Authority of New York and New Jersey.

Real estate professionals also see signs that the owners and tenants are responding creatively to the relatively cheap prices of downtown property. A number of investors, including Donald Trump, are developing plans to convert office towers into apartment buildings.

Finally, real estate experts are encouraged by the keen investor interest in office buildings downtown as well as the rest of Manhattan. Paramount Group, a German company, purchased Financial Square, at 32 Old Slip, for $135 million, a much higher price than many thought the property would fetch. Bidding also was aggressive for the 550,000-square-foot building at 850 Third Ave., which was ultimately acquired by Chicago-based investor Sam Zell for $68 million.