In Atlanta, Irrational Building Exuberance

By ALEX FRANGOS ATLANTA -- A one-mile stretch of Atlanta's upscale Buckhead neighborhood shows why commercial real estate is emerging as an obstacle to pulling the U.S. economy out of recession. Separate developers in Buckhead are building four speculative office buildings at the same time with virtually no leasing activity. The 35 recent condominium projects will help give Atlanta a 40-year supply at the current sales pace. A $600 million outdoor shopping mall under way has suspended construction to save money. View Interactive The glut threatens to worsen the clobbering that many U.S. banks already are getting from nonperforming loans made to owners and developers of office buildings, shopping centers, condos and other commercial real estate. At Bank of America Corp., first-quarter results announced Monday included a surge in the percentage of commercial real-estate loans that are nonperforming to 7.5% of the Charlotte, N.C., bank's total portfolio of such loans. In Buckhead, Bank of America financed two of the four speculative office buildings just steps away from each other, despite little evidence there was demand for more than one of them. It also provided a loan for the Streets of Buckhead luxury retail development, now struggling as some retail tenants flee and go bankrupt. There already are two other luxury malls there. A Bank of America spokeswoman declined to comment. The Federal Reserve's most recent "beige book" survey of regional economic conditions, released last week, found that commercial real-estate conditions "continued to deteriorate over the past six weeks." Demand for space fell, the supply of sublease space rose and property values moved lower as reality "set in," the survey found. The Atlanta projects reflect the sort of exuberant reasoning that developers and their bankers used in justifying real-estate investments now facing declines in value. Atlanta also shows how the broader economic downturn and financing drought are hammering commercial real estate. Last month, a downtown office building bought at the top of the market was forced into a foreclosure proceeding. An auction is set for May 5. David Walter Banks The Sovereign tower, a project by Regent Properties, opened in mid-2008 and has managed to lease three-quarters of its space. The slump in the commercial real-estate sector could be a drag on the economic recovery. While some of the Atlanta projects already are defaulting on loans, others won't start running into financial problems for months or years, with a crescendo of loan maturities starting in 2010. About $248 billion in commercial real-estate debt comes due this year, according to Foresight Analytics LLC. In 2010 and 2011, a total of $566 billion matures. While most other cities haven't seen as much speculative office development as Buckhead, many are suffering from an oversupply of new condos and retail space. Other places are hurting as surplus office space is dumped by companies and from declining values of properties purchased when times were good. "This is about as bad as it's been in modern times, and we haven't even seen most of the commercial damage yet," said Tom Bell, chief executive of Cousins Properties Inc., the Atlanta developer of one of the four towers. "It's going to be a rocky road for a while." He, like his three competitors, is bullish about his own project over the long term. Cousins led Buckhead's most recent development boom. Taking advantage of a sewage project that made development possible, the company built a glass pinstriped tower called Terminus 100. It filled quickly with financial-services firms and other tenants after opening in 2007. "It riveted the development community," said Ken Ashley, an office-leasing broker with Cushman & Wakefield. The math was compelling. Office buildings were selling for $400 a square foot, while you could build one for $300 a square foot, according to Kris Miller, president of Ackerman & Co., an Atlanta real-estate firm. Fill a 500,000-square-foot building with tenants and then flip it to the next guy with various fees added, and you could make about a $45 million profit, he said. The first building to follow Terminus 100 was a project by Regent Properties called the Sovereign. It opened in mid-2008 and has managed to lease three-quarters of its space. After the Regent building came Terminus 200, Cousins's encore to its successful first tower, built next-door. It broke ground in early 2007. Mr. Bell, of Cousins, figured the other companies planning towers would fall away when they saw his bulldozers preparing the site. But the others didn't stop. Mr. Bell describes stages of bewilderment as the other three projects moved forward so quickly. The Buckhead market on average absorbs 300,000 square feet a year, said Lanie Rea, a research manager at brokers Jones Lang LaSalle. That is less than the size of each tower. Tishman Speyer Properties, of New York, started the second tower of the bunch, just up the road. Lehman Brothers Holdings Inc. is an equity partner, and Bank of America provided the $116 million construction loan. A third building led by a consortium of developers including Pope & Land Enterprises and Duke Realty Corp., broke ground in mid-2007. Bank of America again provided the financing: $108 million for the office portion of the mixed-use project, which also includes condominiums. A spokeswoman for the developers said there has been a "tremendous amount of activity" among prospective tenants at the building. Canadian insurer Manulife Financial Corp. and Crescent Resources, a developer owned by Duke Energy Corp. and a unit of Morgan Stanley, was last. It launched Phipps Tower in March 2008, days before Bear Stearns Cos. collapsed. Regions Financial Corp., a Birmingham, Ala., bank, arranged the $95 million construction loan. A Regions spokesman declined to comment. Mr. Bell, at Cousins, was incredulous that Crescent and Manulife went ahead. "I threw up my hands. The world's gone crazy," he said. Terry Gilliam, Manulife's regional director in Atlanta, said Mr. Bell and the others knew the Phipps site, which some local brokers consider the best located, was ready to go. "I would ask why they would do it. They knew the Phipps site was there all along," said Mr. Gilliam. He said Manulife is pleased to be in the project and intends to stay for the long haul. The Cousins building is the only one of the four to find a tenant: a 50,000-square-foot lease with Firethorn Holdings LLC, a mobile-banking company. Prospects that the Buckhead buildings will fill quickly are dim. Buckhead relies on financial-services companies as its best tenants. Those jobs are disappearing. What tenants they do attract are likely to poach from existing landlords, hurting the overall market. —Lingling Wei contributed to this article. Write to Alex Frangos at alex.frangos@wsj.com