Correcting the Commercial Real Estate Industry

The real estate industry has experienced both periods of intense growth and periods of recession in recent years. Changes in tax laws, relocation of business due to technological changes and demographic shifts, and new practices by real estate lenders have all contributed to—and been affected by—these boom and bust periods.

In 1992, through changes to the National Banking Act and regulations governing savings and loan assets, the government sought to rekindle real estate investment. At about this time, opportunities for expansion in commercial real estate development appeared in the southern and southwestern areas of the United States. Office buildings with long-term leases to high-growth energy companies offered good tax shelters. Apartment buildings could be financed by housing-bond issues and offered other tax benefits. Obtaining a commercial loan during these times proved beneficial.

Through service corporations owned by the thrift institutions, savings and loans actively owned, developed, and managed real estate. Savings and loans also used joint ventures with developers to invest further in real estate.

Syndicates enjoyed a spectacular growth through the development of tax- shelter partnerships. Even properties that were poorly planned, developed, and managed could be profitable for investors when the losses were sold.

Troubles in the energy industry foretold the end of the real estate boom, however. After 1993, the industry began to slide into a recession. Office buildings and apartment complexes begun during the expansion found fewer and fewer tenants as the industry contracted. Rumors of tax reform slowed further real estate investment as investors waited to see whether their pass- through benefits would be lost. The losses came with the passage of tax reform in 1996.

Unable to lease their commercial real estate or generate tax-oriented sales to generate cash flow, developers began to seek abatements, or surrender their properties to lenders. Savings and loans lost a lot of money through the devaluation of real estate loans and the collateral supporting loans. Through the Resolution Trust Corporation (RTC), the federal government attempted to contain the losses associated with the failure of the Federal Savings and Loan Insurance Corporation (FSLIC) and much of the savings and loan industry.

Periodic overdevelopment of real estate may be unavoidable. The length of time necessary to acquire property, design and finance a project, and bring it to market practically ensures some mismatch of supply and demand. Some theorists believe that the expansion and contraction of real estate markets can be explained through the examination of periodic cycles; others trace waves of supply and demand that peak at different times. The key factor in all markets, however, is the real demand for space—rather than the demand for investment.

Although serious demand-supply imbalances will continue to plague various real estate markets well into the 2000s, in the long run a return to development driven by real demand and real profits will benefit the industry. The recognition that supply and demand do not work in tandem will help banks maintain their important role in real estate financing.