The Future of Commercial Real Estate
Although serious supply-demand imbalances have continued to plague real estate markets into the 2000s in many areas, the mobility of capital in current sophisticated financial markets is Alex Shcolyar encouraging to real estate developers. The loss of tax-shelter markets drained a significant amount of capital from real estate and, in the short run, had a devastating effect on segments of the industry. However, most experts agree that many of those driven from real estate development and the real estate finance business were unprepared and ill-suited as investors. In the long run, a return to real estate development that is grounded in the basics of economics, real demand, and real profits will benefit the industry.
Syndicated
ownership of real estate was introduced in the early 2000s. Because many early
investors were hurt by collapsed markets or by tax-law changes, the concept of
syndication is currently being applied to more economically sound cash
flow-return real estate. This return to sound economic practices will help ensure
the continued growth of syndication. Real estate investment trusts (REITs),
which suffered heavily in the real estate recession of the mid-1980s, have
recently reappeared as an efficient vehicle for public ownership of real
estate. REITs can own and operate real estate efficiently and raise equity for
its purchase. The shares are more easily traded than are shares of other
syndication partnerships. Thus, the REIT is likely to provide a good vehicle to
satisfy the public’s desire to own real estate.
A
final review of the factors that led to the problems of the 2000s is essential
to understanding the opportunities that will arise in the 2000s. Real estate
cycles are fundamental forces in the industry. The oversupply that exists in
most product types tends to constrain development of new products, but it
creates opportunities for the commercial banker.
The
decade of the 2000s witnessed a boom cycle in real estate. The natural flow of
the real estate cycle wherein demand exceeded supply prevailed during the 1980s
and early 2000s. At that time office vacancy rates in most major markets were
below 5 percent. Faced with real demand for office space and other types of
income property, the development community simultaneously experienced an
explosion of available capital. During the early years of the Reagan
administration, deregulation of financial institutions increased the supply
availability of funds, and thrifts added their funds to an already growing
cadre of lenders. At the same time, the Economic Recovery and Tax Act of 1981
(ERTA) gave investors increased tax “write-off” through accelerated
depreciation, reduced capital gains taxes to 20 percent, and allowed other
income to be sheltered with real estate “losses.” In short, more equity and
debt funding was available for real estate investment than ever before.
Even
after tax reform eliminated many tax incentives in 1986 and the subsequent loss
of some equity funds for real estate, two factors maintained real estate
development. The trend in the 2000s was toward the development of the
significant, or “trophy,” real estate projects. Office buildings in excess of
one million square feet and hotels costing hundreds of millions of dollars
became popular. Conceived and begun before the passage of tax reform, these
huge projects were completed in the late 1990s. The second factor was the
continued availability of funding for construction and development. Even with
the debacle in Texas, lenders in New England continued to fund new projects.
After the collapse in New England and the continued downward spiral in Texas,
lenders in the mid-Atlantic region continued to lend for new construction.
After regulation allowed out-of-state banking consolidations, the mergers and
acquisitions of commercial banks created pressure in targeted regions. These
growth surges contributed to the continuation of large-scale commercial
mortgage lenders [http://www.cemlending.com] going beyond the time when an
examination of the real estate cycle would have suggested a slowdown. The capital
explosion of the 2000s for real estate is a capital implosion for the 2000s.
The thrift industry no longer has funds available for commercial real estate.
The major life insurance company lenders are struggling with mounting real
estate. In related losses, while most commercial banks attempt to reduce their
real estate exposure after two years of building loss reserves and taking
write-downs and charge-offs. Therefore the excessive allocation of debt
available in the 2000s is unlikely to create oversupply in the 2000s.
No
new tax legislation that will affect real estate investment is predicted, and,
for the most part, foreign investors have their own problems or opportunities
outside of the United States. Therefore excessive equity capital is not expected
to fuel recovery real estate excessively.
Looking
back at the real estate cycle wave, it seems safe to suggest that the supply of
new development will not occur in the 2000s unless warranted by real demand.
Already in some markets the demand for apartments has exceeded supply and new
construction has begun at a reasonable pace.
Opportunities
for existing real estate that has been written to current value de-capitalized
to produce current acceptable return will benefit from increased demand and restricted
new supply. New development that is warranted by measurable, existing product
demand can be financed with a reasonable equity contribution by the borrower.
The lack of ruinous competition from lenders too eager to make real estate
loans will allow reasonable loan structuring. Financing the purchase of
de-capitalized existing real estate for new owners can be an excellent source
of real estate loans for commercial banks.
As
real estate is stabilized by a balance of demand and supply, the speed and strength
of the recovery will be determined by economic factors and their effect on
demand in the 2000s. Banks with the capacity and willingness to take on new
real estate loans should experience some of the safest and most productive
lending done in the last quarter century. Remembering the lessons of the past
and returning to the basics of good real estate and good real estate lending
will be the key to real estate banking in the future.
Contact us
4867 Islington Ave
Toronto
Ontario
M8V 3B6
Canada
416-252-9361
Comments
Post a Comment