Only a few years ago, even the most optimistic real estate gurus predicted the Greater Boston real estate market was so bad and inventory so abundant that no space would be built for the foreseeable future.

They were right -- then, at least. After all, the vacancy rate was hovering at more than 20%; the local economy was flat and Boston's major corporations were shedding space left and right. Eager to fill their vacant buildings, landlords were offering every possible concession either to keep existing tenants or attract new ones.

But how quickly things change.

Today, Greater Boston is in the midst of a so-called building boom. At least 18 build-to-suit and three new expansion projects are under way or finalized. Together, these projects total 3.26 million sq. ft. of new commercial space. In addition, a 40,000 sq. ft. speculative office building opened earlier this year at 2310 Washington St. in the Boston suburb of Newton, and another 70,000 sq. ft. speculative office building at 18 Commerce Way in Woburn is about to be completed this fall.

Furthermore, at least 10 companies are scouting land sites for future development in Greater Boston, industry insiders say.

But don't be fooled by this new building boom. Unlike the uncontrolled speculative buildings of the mid- to late-1980s, the new development is led by build-to-suit projects, where developers construct buildings to the specifications of a tenant. The cost of construction is figured into the rental amount of the lease, which is usually for a long term.

The local market has also become awash in capital. Commercial lenders, who virtually stopped lending activities after the real estate market crashed in the early-1990s, are now back and willing to consider all types of loans.

"We think that there is a lot of interest in financing properties in Greater Boston," says Stan Sidel, a principal and president of Spectrum Financial Corp., a Waltham-based mortgage banking firm. "In the early '90s, nobody wanted to lend money. Now, that has changed. Lenders have come back to the market."

He says a new diversity in both the Greater Boston economy and the users of real estate have made commercial mortgage lenders more comfortable with the local market.

"They really spread the risk. Lenders who have not traditionally lent here have found this area attractive because this gives them geographic diversification," Sidel says. "It's a pretty choice place to be if you are a lender. But these are not foolish loans. They are very carefully underwritten."

He says every lender has his or her own favorite in Greater Boston, but apartment is everybody's first choice, followed by industrial and single-tenant warehouse buildings. He says office buildings have come back too, and retail offers mixed opportunities.

"Everybody wants to do a shopping center that is anchored by Shaw's and Stop & Shop," Sidel says. "Shopping centers with troubled or bankrupt tenants such as Caldor and Bradlees are finding it hard to finance."

One of the reasons for increased lending and building activities has been the faster than expected pace of real estate recovery and optimistic predictions for 1996 and beyond.

Although vacancy rates vary from one brokerage firm to another, quarterly reports from all firms indicate that the Greater Boston market remains one of the most healthy in the nation.

Office

With a vacancy rate approximately four percentage points below the national average, overall vacancy in the 101.76 million sq. ft. office market in Greater Boston fell to 9.3% at the end of June, down from 11.8% a year ago, according to Boston real estate firm Spaulding & Slye. Quoted rents rose to $22.80 per sq. ft. from $21.36 per sq. ft. during the same period.

Vacancy rates in 39.35 million so. ft. R&D market fell to 14.4% at the end of June as compared with 18.9% a year ago. Average rent in the R&D market has been on a steady upward trend since the third quarter of 1995, when it stood at $6.70 per sq. ft. on triple-net basis. The rent now stands at $7.41 per sq. ft., according to Spaulding & Slye.

Greater Boston's 47.31 million sq. ft. industrial market has also shown some improvement. The vacancy fell to 18.8% at the end of June from 19.7% a year ago. Quoted rental rents increased to $4.62 per sq. ft. from $4.46 per sq. ft. a year ago.

Michael Sherman, president of Boston real estate firm Whittier Partners, says that after the late'1980s topped out in terms of net absorption, Boston stopped creating new space.

He says vacancy in the 160 million sq. ft. office and R&D buildings in Greater Boston has declined to 9.3%, down from about 25% in 1991.

"The economy has come back slowly first in 1992-93 and then in 1994," Sherman says. "In five and a half years, we have used up 60% of the vacant space. Now we are 90% occupied and less than 10% empty. In three years, you will have no space left."

He says Greater Boston experienced 4 million sq. ft. of net absorption in 1995, and the market is on track to match that this year. The market has already absorbed 2 million sq. ft. during the first six months of this year.

If this trend continues as is expected, vacancy rate in Greater Boston will decline to 6% next year, Sherman says.

"If it gets down to 5% or below, it's a full market. We are getting down to a point where there are a very few places to rent. There are not many choices. There is a lot of competition for space that is already in the market," Sherman says. "At this point, people are focusing on build-to-suits."

"Rents are not high enough for speculative construction. Mortgage lenders have adopted very cautious underwriting standards. They will only lend a smaller percentage. Viable financing for new construction is available but only after tenants have already signed for the whole building," Sherman says. "Most developers cannot get the money."

But the suburban market is a different story, Sherman says. The development cost of a suburban office building is about $26 per sq. ft., and suburban rents have already reached approximately $30 per sq. ft. Sherman says the first speculative developments will take place in the suburbs -- long before it will be seen in downtown Boston.

He says the big question is what will happen if the stock market crashes or if high-tech and financial services companies, that have become the engine of growth of the local real estate market, suffer a slowdown.

"Strength of the market hinges on the stock market. We are so hung up on mutual funds," Sherman says.

Just look at the net absorption by the mutual fund industry alone.

Net absorption in proper Boston's 45 million sq. ft. office market during 199395 was 2.1 million sq. ft., and mutual fund companies accounted for more than two-thirds of this space, according to Boston brokerage firm Lynch Murphy Walsh & Partners Inc.

Of that, 75% was taken by a single user, Boston mutual fund giant Fidelity Investments. Here is the breakdown: Net absorption for 1995 was about 550,000 sq. ft., of which Fidelity alone was responsible for almost 400,000 sq. ft.; in 1994, net absorption was 1.2 million sq. ft., and Fidelity accounted for more than 600,000 sq. ft.; in 1993, while non-Fidelity tenants dumped 200,000 sq. ft. more space than they absorbed, Fidelity reported net absorption of 600,000 sq. ft., resulting in an overall net absorption of 400,000 sq. ft.

Tom Collins, managing director of Cushman & Wakefield of Massachusetts Inc., says the market remains not only tight but also extremely volatile because of a new breed of tenants and their changing needs.

The security of the 1950s, '60s and '70s when corporations made long-term lease commitments are virtually over, Collins says. The tenants of the '90s are mostly software companies, networking firms, biotechnology and other high-tech related operations who cannot plan for long terms because technology is changing so rapidly.

"Software products are good for five years -- maybe even for a lesser period. In today's marketplace, 10-year leases are anomalies," Collins says. "All these factors add some sort of volatility to the market. It's not a bullet-proof marketplace."

Still, however, those with empty spaces across the board no longer have to scout tenants because there is more demand for good space than the supply.

"It has become a landlord's market. There is no time for negotiations -- whether it's new lease, sublease or renewal of a lease," Collins says. "Tenants now need enough information more than ever. It's important that they have brokers with better information."

For example, there are only three choices for leasing 50,000 sq. ft. of contiguous office space in downtown Boston: 99 High St., 225 Franklin St. and 28 State St., which is under extensive renovation and is expected to come back on the market next year, Collins says.

"All developers that are still left around in the market are calling on us to find out about potential tenants. They are talking with potential tenants," Collins says.

He says that although the pressure for new construction is building, Boston may not see a new speculative building in the immediate future.

"There is a healthy demand for space, and there is not a lot of space," Collins says. "But, there is also a lack of financing. Rents have increased in the last five years, but there is still not enough support to propel construction."

Leasing and sales activities, however, have been extremely strong both in suburbs and downtown, says David Pergola, senior vice president and a principal of Boston real estate firm Meredith & Grew Inc.

"There is a whole group of buyers who feel very comfortable with Boston real estate," says Pergola, adding that suburbs remain ahead of downtown in terms of sales and leasing transactions.

He says two major suburban office parks are currently on the market: the 405,600 sq. ft., five-building Unicorn Park in Woburn for about $50 million and the 950,000 sq. ft. New England Executive Park in Burling ton for approximately $ 100 million.

Cigna Corp., the Hartford, Conn.-based insurance giant, recently acquired a 278,000 sq. ft. office building at 25 Mall Road in Burlington for more than $40 million from Boston's Copley Real Estate Advisors Inc. Earlier this year, Cigna also purchased Katahdin Woods, a 128-unit luxury apartment complex in Lexington for $25 million.

Last year, the Shorenstein Co., a San Francisco, Calif.-based real estate investment and development firm, purchased the premier 829,000 sq. ft. Bay Colony Corporate Center in Waltham for $163 million from New York based London & Leeds Development Corp., the U.S. real estate subsidiary of Britain's Ladbroke Group PLC.

"Because of a lack of speculative development over the last years, we have a solid recovery. There is much more balance in the market in terms of supply and demand," Pergola says.

Foreign investors

Jeffrey Swartz, a principal and senior vice president of Boston real estate firm Spaulding &c Slye, says Greater Boston real estate has come full cycle from user market to a high-end investment market where both national and foreign investors are scouting investment properties.

He says foreign investors from all corners of the world, especially the Middle East, Central Europe, Canada and the Pacific Rim are flocking to Boston.

The Boston buildings that have recently been purchased by foreign investors include: the 463,691 sq. ft. 125 Summer St. for $105 million by Deutche Bank, the 821,000 sq. ft. 75/101 Federal St. for $153 million by Dutch Metal Workers Pension Fund (with Boston-based Beacon Properties Corp.) and the 115,000 sq. ft. 84 State St. for $18.8 million by TMW R.E. of Germany.

German investors were also behind Boston-based Berkeley Investments in their acquisition of the Omnibus Portfolio of former Harold Brown properties which included buildings such as 74, 80, 90, 96 100 and 110 Commerce Way, 85 Devonshire St., 230 Congress St. (since sold), 111-119 Beach St. and 695 Atlantic Ave.

In a survey conducted late last year by the Association of Foreign Investors in U.S. Real Estate, a Washington, D.C.-based organization of foreign real estate industry and institutions based outside the United States with interest in the U.S. real estate market, placed Boston for the first time as one of the top five preferred cities for foreign investment.

Boston placed third, missing a tie with second-placed Washington, D.C., by one vote, according to the annual survey, which first began in 1992. Atlanta ranked No. 1.

Pension funds

Spaulding & Slye's Swartz says the most money, however, is coming from national pension funds.

"They are investing directly through their advisors and through commingled funds," Swartz says. "There is a tremendous amount of interest in Boston properties."

He says there is a big demand for the high-quality, well-located and well-leased properties in the suburbs. Top suburban office properties are being sold for 85% to 100% of their replacement value. Suburban R&D is being sold at 75% to 90% of their replacement cost. Downtown office buildings are still getting only about 75% of the replacement cost.

"Suburban industrial is flat this year. The big move in suburban industrial market was in 1995," Swartz says. "The suburban R&D had the biggest gap to close."

Swartz says the value of suburban R&D properties had peaked at $10 per sq. ft. in the late '80s before plunging to $4 per sq. ft. in the early '90s.

"Now they are back to between $7 and $8 per sq. ft.," Swartz says. "The suburban office market has increased in value."

He says the value of downtown properties grew at a faster clip during 1993-94 and early-1995, but has been relatively flat in 1996.

During the first six months of this year in Greater Boston, there were 97 commercial building sales, worth $377.51 million, according to a new study by Whittier Partners. In calendar year 1995, commercial sale transactions totaled 196, worth $1.61 billion. It compares with 190 transactions, worth $841.08 million in 1994; 194 transactions, worth $694.81 million in 1993; and 144 transactions, valued at $385.73 million in 1992.

Mark Kisiel, president of Boston's Leggat McCall/Grubb & Ellis, says the new owners of Boston's real estate are much different than the previous ones.

"Since 1989, we have had a transfer of ownership from the entrepreneur to the institutional form title," Kisiel says. "As you look around downtown Boston today, you see institutions own most of the local office space."

REITs

Boston, for example, has become a Mecca for investments by real estate investment trusts in recent years.

It is estimated that REITs have invested at least $1.2 billion in all types of Boston area commercial real estate since 1992. Here is a partial breakdown: Boston-based Beacon Properties Corp., $416 million; Chicago-based General Growth Properties Inc., $265 million (Natick Mall); Boston's MGI Properties, $130 million; Cornerstone Properties Inc. of New York, $105 million; Los Angeles-based Starwood Lodging Trust, $100 million (Park Plaza Hotel); Newton-based Hospitality Property Trust, $69.9 million; Wilton, Conn.-based Avalon Properties Inc., $60 million; Cleveland-based Developers Diversified Realty Corp. (Shoppers World in Framingham); and Dallas-based Patriot American Hospitality Trust, $16 million (Tremont House Hotel).

"We have gone through a very rapid recovery in the market. The vacancy rate has dropped from the upper teens to a point today just below 9% in Class-A space," Kisiel says. "However, rental rates have increased only 25%. My conclusion is that if ownership had not changed and was still in the hands of entrepreneurs, rents would be $4 to $5 per sq. ft. higher today."

He says an institutional asset manager is not rewarded personally on what effective net rental increase is on the property, but on the basis of occupancy.

"His prime challenge is to get the building filled up. He is rewarded on occupancy in the building," Kisiel says. "An entrepreneur, on other hand, is really interested in both. He is driven to a high degree in increasing the bottom line rent."

He predicts Boston will see a few leasing opportunities and only a moderate increase in rents in the next three to four years.

"By the turn of the century, rents will be up another 12% to 15%," Kisiel says.

Despite lower vacancy, the rents are not rising at par with the tightening of the market because many downtown tenants are relocating their backroom operations in suburbs where rents are 30% cheaper in downtown Boston, Kisiel says.

Some downtown tenants who have relocated some of their operations to the suburbs include financial services firms such as Fidelity Investments, Scudder Stevens & Clark Inc., Putnam Investments and First Data Corp., among others.

"We are seeing an interesting phenomenon. I don't remember seeing this at this scale before," Kisiel says. "There are isolated cases where rents in the suburbs are even greater than in downtown. This has not happened in the past. I think you are going to see, in the next 18 months, a return in the suburban marketplace of speculative construction because demand clearly exceeds the supply. My guess is that we are not going to see a new office product (besides 28 State St.) downtown before several years after the turn of the century."

He says one of the reasons it would not happen first in the downtown is because no tenant would prelease space in a future tower because it takes two years of permitting and an addition two to three years of construction for a tower.

"A downtown tenant would have to plan out his needs at least five years from today. In the suburban market, that time frame is less than half of that," Kisiel says. "The capital is not available to build a 600,000 to 800,000 sq. ft. building on a speculative basis. The first spec building should be smaller, in the 400,000 sq. ft. range or less."

Joseph Fallon, a principal at Boston brokerage firm Fallon, Hines & O'Connor Inc. who specializes in the suburban market, says both office and R&D markets have seen a dramatic increase in activities during the last two and a half years in the suburbs.

The unprecedented growth has been spearheaded by economic sectors such as financial services, telecommunications, software and other high-tech-related firms.

He says it has become difficult to find 5,000 sq. ft. to 10,000 sq. ft. of contiguous office space in suburbs.

"Downtown tenants don't see that pressure yet. Multiple companies are bidding for space in the suburbs. At least five or six tenants are looking at the same space," Fallon says. "Tenants are having to make decisions on opportunities much quicker than ever before."

The vacancy rate in the 44.41 million sq. ft. suburban office market dropped to 8.5% at the end of June from 11.2% a year ago, according to Spaulding & Slye. Rents rose to $17.47 per sq. ft. from $16.30 per sq. ft. during the same period.

Metrowest

One of the new suburban hot spots is Greater Boston's Metrowest market, says Christopher Egan, president of Carruth Capital, a Westborough-based real estate development and investment firm that owns about 1 million sq. ft. of space in the Metrowest market.

"It's getting crazy. It's getting like the '80s. We have no vacancy," Egan says. "We have started the permitting process for a 100,000 sq. ft. speculative building to start next year."

The Metrowest market covers 8.8 million sq. ft. of office space, 9.7 million sq. ft. Of research and development and 12.1 million sq. ft. of warehouse/manufacturing. Most of the Metrowest market falls within Western Route 128 and 495, including Natick/Framingham area, Westborough, Hopkinton, Hudson and other neighboring towns.

Real estate brokers working in the area say that the values of commercial properties in Metrowest have doubled since 1991, and effective rents have almost reached the peak levels of 1986. The spike in the Metrowest market has been largely caused by tightening on the Route 128 market. Growing office tenants relocating from Boston, Cambridge and other suburbs, who cannot find space on Route 128, are now moving along the Route 495 Beltway.

Egan says investors are bidding higher and higher on properties. Rents have gone up from $14 per sq. ft. 18 months ago to $19 per sq. ft. for first-class office space in the area.

"If you look at the Metrowest market in general, vacancy is very very low. I don't know anyone who has vacancy. This market has taken a 180 degree turn since 1993," Egan says. "I see new construction coming in next year."

He says all buildings that were previously occupied by computer giants such as Digital Equipment Corp., Data General, Prime Computers and others and were vacated during the downturn of the early 1990s, have been filled up by a new breed of smaller and fast-growing high-tech companies.

They are outgrowing their space quickly Egan says,

William Poorvu, a professor of real estate at Harvard Business School, says real estate recovery in the suburban markets, especially along Route 128, has been possible largely due to these new high-tech entrepreneurs.

"A lot of people who left Digital and other companies started to set up their own firms, and they have been growing very fast," Poorvu says. "It has been very healthy for the Route 128 market."

Route 128, which encircles Boston at a distance of about 10 miles, is approximately a 50-mile stretch from Gloucester to Southshore. But the real core extends about 20 miles to 30 miles from Dedham to Peabody.

Commercial properties lining north-and south-bound lanes of legendary Route 128, once known as "America's Technology Highway", bore the worst of the real estate downturn in the early '90s.

Cambridge

The 9.65 million sq. ft. Cambridge office and R&D markets also remain hot, and it's difficult to find large blocks of space. The first six months of this year saw a strong demand for space in Cambridge, led by software and Internet firms along with a resurgence in the biotech sector.

The higher pace of activity pushed up office rents in Cambridge to $24.14 per sq. ft. at the end of June, up from $21.58 per sq. ft. a year ago, according to Spaulding & Slye. The vacancy rate in Cambridge declined to 4.2% from 7.9% during the same period.

Multifamily

With a vacancy rate of just 3%, the Boston-area apartment market ranks among the top 12 multifamily investments markets in the country, according to Los Angeles-based E&Y Kenneth Leventhal Real Estate Group.

George Lieser of Rockport Mortgage Corp. says that multifamily is the best sector in Boston. His company recently closed on a $12.2 million Freddie Mac refinancing of the Demeter apartments in the Back Bay neighborhood. The apartments total 18 buildings containing 207 units; they currently have no vacancies and are implementing rent increases.

"Multifamily housing in metropolitan Boston continues to be the strongest real estate property type and is the most often sought collateral for investment," says June K. Fish of Ashworth Mortgage Corp. "With Boston and Cambridge rent control eliminated, rents are steadily increasing to re-align with supply and demand economics. It's important to note there are lenders today who will wait out the increase in rents by committing to an initial loan funding based on today's economics while also providing earnouts for properties which have yet to reach their economic/market rent."

Leonard Samia, president of Boston' based The Samia Cos., which owns 2,500 units, from single-family to 320-unit complexes, says occupancy remains very high, but rents have not inched up if inflation is taken into account.

Rents at one of Samia's Boston properties have risen only to between $660 and $685 per unit per month at present from about $650 in 1989.

"If you factor in the 7% annual inflation of the last seven years, rents have actually dropped," Samia says. "But the fact is the local market remains extremely tight."

Hotels

Another hot segment is the Boston/Cambridge hotel market.

The local hospitality market, which had bled during the early-1990s from low occupancy and declining room rents, has come roaring back -- so much so that it is on the verge of a hotel building boom.

Carr Capital is currently involved in a downtown hotel project. "Carr Capital is actively involved in providing financing for several downtown redevelopment projects including the redevelopment of the Battery March building, an office property in the financial district, which is being converted into a 362-room, limited-service business hotel," says Oliver T. Carr III, principal. "To date, the credit markets have been very receptive to the project due to the pent-up demand for a well-located, limited-service hotel."

Art Canter, executive director of the Massachusetts Lodging Association, says that an estimated 4,000 new hotels rooms are either under construction or on the drawing board in Boston and Cambridge. At least 2,000 of them are definite.

If all 4,000 rooms are built, the Boston/Cambridge room inventory will rise by more than one-fourth to 19,000 rooms from about 15,000.

Retail

One sector that is not doing so well is retail real estate mainly because of poor performance by many regional discount retailers. Braintree , Mass.-based Bradlees Inc., which operates more than 125 stores from Philadelphia to Boston metropolitan areas, and Norwalk, Conn.-based Caldor, with more than 150 discount retail stores in the Northeast and Mid-Atlantic, last year filed for bankruptcy protection from creditors under Chapter 11.

As a result of the retail downturn, several institutional investors have decided to slowly decrease their portion of the regional mall portfolio in the New England region. Many investors, however, still want to have retail in their real estate portfolios but are shying away from power centers and discount stores.

Repeated efforts by the city of Boston to revitalize downtown retail has failed. Macy's, a major downtown retailer, has decided to downsize its store significantly. Last year, Filene's abruptly canceled plans for a three-story expansion of its flagship store in downtown just four months after widely publicizing its expansion plan. The nearby Lafayette Mace mall has been vacant since 1992, and its future still seems unclear.

But there is some silver lining for downtown. Marshalls, which was acquired by Framingham, Mass.-based T]X Cos. last year, is scheduled to open in downtown Boston this fall. It will now join Borders Books which opened earlier this year at 10-24 School St. Loehmann's has also opened in downtown at 333 Washington St.

"They collectively amount to all retail space leased in the Downtown Crossing area during the last 15 years," says Joseph Levanto, a principal of Schaffer & Associates, a Boston retail real estate brokerage firm specializing in downtown Boston.

He says Border Books, Loehmann's and Marshalls are the three big tenants that have come to downtown in almost 20 years, taking 30,000 sq. ft. to 40,000 sq. ft. of retail space.