If commercial real estate is to Atlanta what cars are to Detroit, then the engine is kaput, and AAA won’t arrive for more than a year. The Atlanta real estate market is suffering through one of its toughest spans in its history. Office and industrial vacancy rates have reached numbers not seen since the recession of the early 1990s. Apartment owners are offering as many as four months free rent, and hoteliers have seen average occupancy fall 5 percentage points. The job growth that fueled Atlanta’s expansion during the 1990s has evaporated. For the first time in a decade, economists measured job losses in metro Atlanta — and the repercussions were extreme. Office developers started projects expecting 70,000 or more jobs to be added annually. Instead, the number of new jobs actually decreased by 67,000 from April 2001 to April of this year, and some of those new buildings opened with occupancy rates as low as 8%. Companies let inventories deplete, and the need for warehouse space dropped. Apartment builders were hit particularly hard. The same job growth that created demand for office space created demand for new homes. With no job growth, new apartments sat empty and occupancy rates fell. Developers, owners and investors are casting a wary eye on Atlanta. The optimists believe the market is bouncing along the bottom, poised for an upturn. The pessimists say the worst is yet to come. But industry experts are quick to point out that Atlanta usually rebounds from recession faster than other markets because its job growth engine revs quickly. "Atlanta has traditionally led the economy out of the doldrums," says Don Huffner, a senior vice president who oversees the Atlanta region for Equity Office Properties Trust. "You’ve already seen several months of positive employment growth. The fundamentals are here. It’s a high-growth employment market. When the economy turns, Atlanta will bounce back." Office Market Blues But the Atlanta office market still has a ways to go before improvement begins, says Pat Henry, a principal in Trammell Crow Co.’s Atlanta office. "I define hitting bottom as that point where ‘real rents’ are at their lowest point," says Henry. "While we will likely see a strengthening in the overall economy by year-end and into 2003, we will undoubtedly lag in any upswing in the office market." Continued soft demand in the Atlanta office market will force landlords to continue to search for, he adds. Take Hines’ 380,000 sq. ft. One Overton Park office building in suburban Cobb County north of the city, which the Houston-based firm started building at the height of Atlanta’s office market. Now open for 10 months, the 15-story building is only 15% leased. "No one ever could have forecast when we broke ground in the spring of 2000 that things would be where they are today," says Bob Voyles, a senior vice president who heads Hines’ Southeast region. "We’re going to do what we need to do to get deals made. You take the short-term pain to retain the long-term value." How did Atlanta’s office market go from a record year in 2000 to one of its worst periods 18 months later? It’s the demand — or the lack thereof. Unlike the real estate recession of the early 1990s, overzealous developers didn’t cause the current downturn by erecting too much office space. Some examples of bad decisions can be found across metro Atlanta, but for the most part the problem started when Corporate America started cutting back. The same technology and telecommunications companies that helped Atlanta’s office market set a record for net absorption in 2000 punched the industry in the face in 2001 and 2002. These businesses laid off workers by the thousands and gave back large chunks of space, creating a sublease market to which space seemed to be added daily. Companies-turned-landlords scrambled to attract tenants to their sublease space. In north Fulton County, Hewlett-Packard Co. offered 79,000 sq. ft. of space for $7.95 per sq. ft — well below the $19.69 average per sq. ft. for Class-A space reported by CoStar Group for the North Fulton submarket. The low rates forced developers and landlords to respond by lowering their own rents and piling on concessions. But now concessions and rate cuts offered by landlords are flattening, signaling that owners may be on the front-end of a slow-paced recovery, says Mark Lucas, managing director in Jones Lang LaSalle’s Atlanta office. "However, it is too early to say whether this trend will sustain itself long-term," he emphasizes. "While landlords were hoping for a quick recovery, it is evident that office investors throughout Atlanta realize that in order to consummate leases in 2002, aggressive economics have to be conceded." Atlanta’s office market showed some signs of improvement in the first quarter, when it recorded a positive net absorption of 438,000 sq. ft., according to CoStar Group. But a dramatic reversal occurred in the second quarter, when the market had negative net absorption of 604,000 sq. ft., pushing the overall office vacancy rate up about 4 points to 19.2% at mid-year. "During the first quarter of the year, activity began to pick up, so everyone felt that we’d passed the low point on this cycle and could expect the market to begin to improve," says John Shlesinger, executive managing director at Insignia/ESG. "Unfortunately, nobody counted on the disastrous news about accounting scandals at Enron, WorldCom and other once high-flying companies." The bankruptcies of these companies will add a significant amount of space back to an already saturated market supply — WorldCom alone occupied 300,000 sq. ft. in Atlanta’s Central Perimeter submarket. The amount of sublease space ballooned to 7.7 million sq. ft. earlier this year, more than double the amount of sublease space available at year-end 2001, according to Cushman & Wakefield. While vacancy rates continue to rise and rental rates fall, sales prices are increasing. During the first six months of 2002, the average price per sq. ft. for Atlanta office properties rose more than 28% to $137, reports Los Angeles-based CB Richard Ellis. A lack of supply is keeping prices up. Capital sources are chasing deals, but there are few to catch. Sales of Class-A and Class-B office properties totaled $288.4 million through July, according to a report from New York-based Eastdil. That represents a 2.2% increase from the same period last year. Looking ahead, Carter & Associates Vice President Dale Lewis believes the market will begin to stabilize next year. "We should see a settling down in office vacancy in early 2003 and by the end of second quarter a slight turn upward," Lewis predicts. Industrial Drop-Off The same factors that have hurt Atlanta’s office market — lack of demand, negative job growth and corporate indecisiveness — are hampering the city’s industrial market. "The Atlanta industrial market has hit bottom, unless the economy goes into a double dip recession that some economists have warned about," says Jeff Small, president and CEO at M.D. Hodges Enterprises, a Cobb County development firm. According to Small, inventories have declined steadily for 18 months due to the contraction of the manufacturing segment of the economy over the past two years. Now, manufacturing is beginning to show signs of a recovery, which should translate into increased industrial demand over the next 12 months. As of the second quarter of 2002, the industrial sector endured five consecutive quarters of negative absorption, reports locally based King Industrial Realty. The industrial vacancy rate was 14.6% as of the second quarter of 2002, up from 9.6% in the second quarter of 2001, reports CB Richard Ellis. On the sales side, institutional and private investors are snapping up industrial properties. A group of unnamed Chicago investors recently bought a 408,600 sq. ft. distribution center leased to Acuity Brands, a spin-off of National Service Industries. Panattoni Development Co., which developed the building, was not marketing the building, but the Acuity lease — valued at $20 million — attracted an unsolicited offer. Aching Apartment Market Atlanta’s multifamily market stumbled through the first nine months of 2002. From April 2001 to April 2002, the metro area lost 67,000 jobs, according to a report from Encino, Calif.-based Marcus & Millichap, and the vacancy rate for Atlanta’s apartment market rose to 8.5%. That’s an increase of more than 1.5 percentage points from the same period last year. In reaction to the rising vacancy rates, Atlanta’s Post Properties, one of the nation’s leading developers of upscale, urban communities, has implemented a rent reduction program. The strategy has started to show results, Post CEO and President Dave Stockert told analysts and investors in August. "We moved through our recognition of market conditions three months ago, and that may be why we see more stability today," he said. "But we have had a push on to drive occupancy, and we have had some success with that." Despite increased vacancy and decreased rents, Atlanta continues to lead the country in multifamily construction, reports Marcus & Millichap. More than 11,000 units will be completed this year, although permits for multifamily construction have dropped 9% from a year ago. Without a dramatic increase in available jobs, there will not be sufficient renter demand to fill these units, and vacancies will continue to rise. Apartment sales are the one bright spot. Improving market conditions and an overall lack of supply should push up the price of apartment complexes by 3% over the next 12 months, according to Marcus & Millichap. Post, which is selling off the older assets in its portfolio, sold nearly $143 million worth of apartments through July. It’s well on its way to its goal of selling $170 million to $200 million worth of properties this year. Retail Ready to Move After a flurry of mall building in Atlanta’s suburbs in the late 1990s, retail developers are spending 2002 securing positions for the next wave. The Rouse Co. has made the most progress. In the spring, the Columbia, Md., developer secured a commitment from Neiman Marcus to anchor a new 1.4 million sq. ft. mall in Forsyth County in Atlanta’s northern suburbs. The center, which will be called Forsyth Commons, will be part of a mixed-use project on 151 acres just off Ga. 400. In Atlanta’s southern suburbs, collectively known as the Southside, CBL & Associates Properties of Chattanooga, Tenn., has identified potential development sites for a 1 million sq. ft. mall in Henry County and an 850,000 sq. ft. mall in Coweta County. The talk of new retail projects comes even as the vacancy rate is rising. The average vacancy for metro Atlanta’s retail space is expected to increase 1 percentage point to 9.7% this year, according to Marcus & Millichap. The closing of 10 K-Mart stores will add about 1 million sq. ft. of big-box space to the market. The rising vacancy rate has kept the pressure on average asking rents, which fell 3.8% in 2001, reports Marcus & Millichap. Retail construction has declined 40% this year, but that won’t be enough to keep the vacancy rate from increasing. Hospitality Struggles The terrorist attacks of Sept. 11, 2001, continue to impact Atlanta’s hospitality market as fewer people travel for business and conventions. As of mid-year, the occupancy rate for metro Atlanta’s hotels dropped more than 5 percentage points to 60%, according to Smith Travel Research. Room rents fell 3.8% to $79.30, and revenue per average room (RevPAR) dropped 11.7% to $47.59, according to Smith. That hasn’t stopped talk of new hotels, though. Six Continents is planning a 425-room Inter-Continental Hotel on Peachtree Road in Buckhead. In addition, North Point Hospitality of Alpharetta is building a 220-room SpringHill Suites near the Tower Place project in Buckhead, with completion scheduled for 2004. The largest hotel project under way in Atlanta is the 600-room expansion of the Omni at CNN Center. The $100 million, 28-story hotel tower, developed by Turner Broadcasting System and Omni Hotels, is scheduled for completion in late 2003. When finished, the hotel will be the largest in the Omni chain and the fourth largest in the city. The expansion would boost the number of rooms from 470 to 1,070. What’s Next? John Decker, partner at Childress Klein Properties, says Atlanta’s real estate engine will start to crank up next year, but it won’t go from 0 to 60 in 10 seconds. "The smoke and mirrors and capital infusion of high-tech mania will not pull us out this time," he says. "The old economy users will need to save the day during this recovery. Therefore, we foresee a four cylinder rather than a V-12 leading the way out of this depression."