Commercial Real Estate for The Future

Despite the fact that many of the world’s leading economies are in 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 the real estate development and real estate finance businesses are 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.

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 2000s saw a booming cycle in real estate. The natural flow of real estate cycles where demand exceeds supply was applicable during the 1980s and early 2000s. At that time the vacancy rate of offices in most major markets is below 5 percent. Faced with the real demand for office space and other types of income properties, the development community simultaneously suffered an explosion of available capital. During the early years of the Reagan administration, the deregulation of financial institutions increased the availability of the supply of funds, and their savings increased their funds to already-developed creditor cadres. At the same time, the Economic Recovery and Tax Act of 1981 (ERTA) gave investors an increase in “removal” taxes through accelerated depreciation, reducing the capital gains tax to 20 percent, and allowing other income to be borne by “real estate” losses. , more equity and debt funds are available for real estate investment than ever before. 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.

Because real estate is stabilized by the balance of demand and supply, the pace and strength of recovery will be determined by economic factors and its effects on demand in the 2000s. Banks with the capacity and willingness to take on new real estate loans must experience some of the safest and most productive loans made in the last quarter century. Given the lessons from the past and back to the basics of good real estate and a good real estate loan will be the key for real estate banking in the future.

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