Commercial Real Estate: The Future
While serious supply-demand imbalances continue to plague real estate markets in many areas into the 2000s, real estate developers are encouraged by the current mobility of capital in sophisticated financial markets. In the short-term, the loss of tax shelter markets caused significant capital to be withdrawn from real estate. This had a devastating impact on certain segments of the industry. Experts agree that many people who were driven from real-estate development and real estate finance were not prepared and unsuited to be investors. The industry will see long-term benefits from a return to realty development that is grounded on economics, real demand and real profits.
In the 2000s, syndicated ownership of real property was established. Many early investors suffered from collapsed markets and tax-law changes. The concept of syndication was introduced in the 2000s. It is now being used to create more economically sound cash flow-return real property. This will ensure that syndication continues to grow. REITs (real estate investment trusts) were heavily affected by the real estate crisis of the mid-1980s and have since been rediscovered as an efficient way for the public to own real estate. REITs are able to own and manage real estate efficiently, and raise equity for its acquisition. These shares can be traded more easily than shares in other syndication partnerships. The REIT will likely be a great vehicle for satisfying the public’s desire for real estate ownership.
To understand the potential opportunities in 2000s, it is important to review the causes of the 2000s’ problems. The industry is dominated by real estate cycles. While the oversupply in many product types can limit development of new products it also creates opportunities to the commercial banker.
Real estate saw a boom in the decade that followed 2000. The natural flow of real estate cycles, where demand outstripped supply, was evident in the 1980s and 2000s. In most major markets, office vacancy rates were below 5 percent at that time. The development community saw a surge in capital available as there was real demand for office space, and other income properties. Deregulation of financial institutions in the early years under Reagan increased the availability of funds. Thrifts also added funds to the growing number of lenders. The Economic Recovery and Tax Act of 1981 (ERTA), which was passed in 1981, allowed investors to increase their tax “write-off” by accelerating depreciation, reduce capital gains taxes to 20%, and allow other income to be protected with real estate “losses.” This made it possible to invest more equity and debt than ever before.
David Goodnight says Two factors kept real estate development going even after 1986’s tax reform ended many tax incentives and some equity funds were lost. In the 2000s, the trend was towards the development of large or “trophy” real estate projects. Popular were office buildings exceeding one million square feet and expensive hotels that cost hundreds of millions of dollar. These huge projects, which were started before tax reform was passed, were completed in late 1990s. Second was the availability of financing for development and construction. Even after the Texas disaster, New England lenders continued to finance new projects. Lenders in the mid-Atlantic region continued lending for new construction even after the New England collapse and Texas’ continued downward spiral. The regulation that allowed for out-of-state consolidations in banking led to pressure on specific regions due to the mergers and acquisitions by commercial banks. These growth surges contributed to the continuation of large-scale commercial mortgage lenders going beyond the time when an examination of the real estate cycle would have suggested a slowdown. Capital implosion in 2000s real estate was caused by the capital explosion. The thrift industry has no funds for commercial real property. Major life insurance companies are facing mounting real estate losses. Commercial banks are trying to reduce their real-estate exposure by taking write-downs, charge-offs, and building loss reserves for two years. The 2000s’ excessive debt allocation is unlikely to cause oversupply.
There is no new tax legislation expected to impact real estate investment. Foreign investors are likely to have their own issues or opportunities in the United States. Excessive equity capital is unlikely to drive recovery real estate.
According to David Goodnight If there is real demand, then it appears that new development won’t be happening in 2000s. In some markets, the demand for apartments is already higher than supply. New construction has started at a reasonable rate.
Existing real estate will be more attractive if it has been de-capitalized and written at current value to generate acceptable returns. A reasonable equity contribution from the borrower can finance new development that is justified by existing product demand. Because there is not too much competition from real estate lenders, it will be possible to structure loans in a reasonable way. Commercial banks can get excellent real estate loans by financing the purchase of existing property that is de-capitalized for their new owners.
Real estate will stabilize when there is a balance between demand and supply. The economic factors in the 2000s and their impact on demand will determine the strength and speed of recovery. The last quarter century has seen some of the most secure and productive lending. Real estate banking will only be possible if we learn from the mistakes of the past.