High rents point to a topping out in real estate market

In 1972, a lawyer with a law school sheepskin under his arm received a salary of $35,000 here. The cost of the space the young barrister occupied was $12 a square foot, or $2,700 - 7.7 percent of the lawyer's pay.

This year, the first-year lawyer would have received $43,000. But occupancy costs have soared to $50 a square foot, or 26 percent of his compensation.

Barton M. Biggs, managing director for investment strategy at the Morgan Stanley investment banking firm, says about this rise:

''In my humble opinion, the secular bull market in real estate is over.''

The statement was part of a report sent out late last week to the blue chip company's clients. The bull market in commercial real estate is over because the cost of property occupancy has just gotten too high, Mr. Biggs says.

But he adds that he foresees no great collapse in real estate - as happened in 1974 and 1975. Instead he expects a long, drawn-out period of low returns. He compares the coming real estate decline to the underperformance of stocks through the 1970s. He doesn't say people won't make money in real estate - just that it will be much harder to do.

To back up his point on the rising cost of occupancy, he notes that in the last six years the annual cost of leased retail space here rose from a gross rental of $2 a square foot to $6 a square foot. At the same time office rental space has soared to $50 a foot. Similar increases can be found in Dallas, San Francisco, and Denver.

Of course there are reasons that prices have climbed, he says. Builders have experienced a dramatic increase in the cost of capital, labor expenses have gone up faster than high-rises, and speculation has made raw real estate more expensive. Naturally, as tenants agreed to pay higher costs, more builders pulled out plumb lines to put up more office towers. Even though the office vacancy rate has risen from 3.3 percent to 5.8 percent in 17 major cities, Mr. Biggs notes that ''developers blithely plan to add new space equivalent to two downtown Chicagos in the next year and a half.''

Tenants, he notes, are beginning to adjust. Retailers, for example, are downsizing and increasing sales per square foot. As this trend takes hold, even more space will become available.

Biggs also sees another cloud hanging over the office towers: the beginning of a liquidity squeeze on the open-ended, commingled commercial real estate funds, which have pulled in billions of pension fund dollars. In recent years, these funds have shown phenomenal growth rates - averaging 15 to 20 percent a year. Some 40 percent of this return was from increased income and 60 percent from property appreciation. Biggs figures it's likely ''that at least some of their recent appraised valuations are well above what the properties could be sold for.''

Now, for the first time since the funds were begun, some substantial redemptions are being made by pension funds. Mr. Biggs notes that since many new large property committments have been made and new money flows are slowing, the real estate funds are being squeezed. He suspects that they will have to sell-off some of their real estate at below appraised costs, resulting in a drop in the funds' net asset value. This in turn will cause additional redemptions.

Although Mr. Biggs dosen't believe real estate values are going to collapse, he does predict that real estate prices will fall by as much as 20 percent. And, he dosen't look for a bounce back up next year if the economy recovers. Rather, he is predicting real estate will stay down for years.