For those who remember the real estate market doldrums of 1990 to 1992, the U.S. office market is in a state which could be described as "almost too good to be true." The economy is thriving, vacancy rates continue to fall, rents are spiking in selected markets and, best of all, new construction is moderate.

The U.S. economy could also be described as almost too good to be true. Low inflation, low unemployment, and a robust GDP growth prevail and are forecasted to continue into the near future.

Will these buoyant forecasts be interrupted by a cyclical recession? While recessions usually occur every decade, there are good reasons to believe there may be a unique break in the pattern which will affect the U.S. real estate market cycles as well. Throughout economic history, unusually long down cycles have usually been followed by extended upswings - suggesting that near-term growth will continue for a few more years.

Economy bolsters office demand Solid growth in new office employment is associated with this strong economy. Although the forecasts show office employment growth at less than 2% each year (substantially less than real GDP percentage growth), this rate of growth nonetheless adds from 350,000 to 450,000 new office employees each year.

According to Cushman & Wakefield (C&W) research, which tracks 2.4 billion sq. ft. of office space in the United States, the next two years should prove to be excellent ones for the real estate industry from all perspectives, except perhaps the tenant's. At fourth quarter 1997, C&W's national downtown vacancy rate was 11.9%. If all of these economic and real estate market trends were to prevail as expected, these rates would continue to drop to 11% at year-end 1998, and 10% or below at year-end 1999. At the same time, new construction is fairly minimal relative to the size of the markets.

Within the roster of office submarkets, there would be many tight markets with strong rental growth. This kind of positive expectation for the next two years is perfectly consistent with a long cyclical upswing which compensates for at least four years of a highly depressed real estate market.

There are important indications, however, that this real estate cycle upswing will not see the kind of rental growth spikes that were seen in the prior upswing. The large tenants who were once the mainstay of strong rental growth in the major CBDs have become some of the most mobile. Increasing sophistication at cost comparison and strategic planning have made the major tenants poor candidates for exorbitant rental increases. Moreover, the outsourcing of real estate management has provided tenants with the means of leveraging the competitiveness and efficiencies of commercial real estate service firms' practices to the corporation's real estate bargaining position.

Hot markets already slowing down It can be anticipated that some of the "hot markets" will become victims of their own success. As rents rise and available office inventory and labor become scarce, these hot markets will be eliminated from consideration as future locations. In fact, the migration of workers to these hot spots is already slowing.

At the same time, many cities and regions which lagged the national economic recovery show signs of renewed vigor. For example, the migration from the Northeast and from California has slowed as conditions in these regions have improved. Third tier, smaller cities are now being considered for business relocations, as these areas offer unique opportunities to satisfy the business objectives of low costs and available and productive workforces.

Though rental growth may not reach the dizzying heights of the late 1970s, investors should still see solid total returns chalked up in the NCREIF Index of real estate performance. The NCREIF Index has been moving steadily upward, and if all of the positive economic conditions continue, the next two years should see total returns well over 10%.

One question for the longer-term future is the source of capital for the next round of new construction and the timing of the next wave of new construction. Industry analysts look to REITs and their cousins in the public market as sources of capital in part because the public market is rapidly increasing its role in the industry at large, and because it was the only financing sector not to suffer outstanding losses in the prolonged real estate downturn.

So where is the dark cloud? Why are long-term prospects for this market less certain? Because this market has the anticipatory and overeager "feel" of 1987, a year in which the foreign investors and the commercial development and lending sector of the industry began to lose sight of the relationships between oversupply, rising vacancy rates and low (or no) rental growth.

Ten years later, there are other players and other financial and leasing instruments in the market. However, there have already been transactions in the market whose terms seem to ignore the "intrinsic value" and future income potential of the real estate involved, reminiscent of some of the transactions of the late 1980s. These transactions are the harbinger of an overheated market and the dramatic and unpleasant pricing corrections they bring.

Arthur J. Mirante II is president and chief executive officer at New York-based Cushman & Wakefield Inc.