Real Estate Downturn of the Early ’90s Differs From Today’s Crash In Important Ways
By David Lynn, Ph.D.
Many market observers have pointed out similarities between the current downturn in commercial real estate and the downturn in the early 1990s. Both were preceded by an extended period of relaxed underwriting standards, excess capital chasing returns, significant cap rate compression, and steep increases in asset values. It is useful to compare and contrast key elements of the two periods in order to establish a reference point for today’s investment strategies.
Two key regulatory changes during the 1980s paved the way for the overbuilding that defined the 1990s recession in commercial real estate. The 1982 tax cuts included provisions that allowed for generous depreciation allowances and tax shelters for investors. Also during the 1980s, the deregulation of the savings and loan industry allowed these institutions to expand their investments to include commercial mortgages.
The tax laws were changed again in 1986 to remove many of the earlier incentives for real estate investment. But the combination of a general atmosphere of economic recovery, an increasing appetite for real estate investment from institutional capital, and the introduction of the S&Ls as new and often inexperienced lenders for commercial real estate resulted in a massive oversupply of space in many markets.
The silver lining in today’s environment is a general lack of oversupply in most markets. New construction in nearly every sector has been below long-term trends, though some markets are struggling with oversupply problems [Figure 1]. While ample financing was made available for development projects in recent years, the combination of supply constraints and sharply rising land and construction costs helped to keep new supply largely in check.
The recession is reaching all property types, and vacancy rates are expected to approach or surpass 20-year highs. The lack of financing for new construction will likely keep new supply further constrained for some time, helping to improve real estate fundamentals as the economy recovers over the next few years.
FIGURE 1: NEW SUPPLY REMAINS IN CHECK COMPARED TO HISTORIC RATES
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