The 1980s were dynamic and a lot of fun for many real estate professionals. There was a build-up of jobs and wealth even though the decade led off with a recession, unemployment above 10% for the first time since 1940 and business failures at their highest level since 1932. The rate of economic growth was sufficient to coin the phrase "the go-go '80s." At the heart of the growth was leverage - as seductive and two-faced as ever.

This decade became known for its greed, but what was different about the 1980s was the ability to feed the greed with a lot of free and easy capital and to provide higher doses of leverage. Leverage works both ways, of course - magnifying gains as well as losses. Depending on your viewpoint, the result was either the creation of the best buying opportunity that real estate has ever seen, or, the deepest real estate depression in history. The real estate depression, the junk bond fiasco and the S&L crisis were the biggest stories of the decade with the financial maarkets and the volatile economy stealing the show.

The decade started with a national office vacancy rate of 5%, which by the end of the decade was pushing 18%. The development boom in between was the largest in our history: office space doubled to 2.5 billion sq. ft.; the number of shopping centers rose 57%; and hotels surged by 43%. When the dirt settled, there was 12.5 billion sq. ft. of new commercial property standing. The amount of outstanding debt on commercial properties was close to $250 billion in 1980 and by 1989 had nearly tripled to a staggering $745 billion. Unfortunately for investors and lenders, the boom delivered about 10% to 20% more space than was needed. The end of the 1980s was a bloodbath for many in the real estate industry. Shops closed, investors lost barrels of money and S&Ls were shuttered.

Wave of development As the economy rose from the ashes in 1983, the real estate industry geared up for its own version of the go-go '80s. The construction of new space during the 1980s did not begin as a capital-driven event. Office sector employment was growing rapidly and this dramatic growth in white collar and service jobs created a need for space. Although the demand was filled, construction continued for the sake of construction.

Apart from the strong demand for more space, there were other factors that brought about this massive wave of development. Working off of Ronald Reagan's supply-side economic plan, the federal government passed the Economic Recovery Act in 1981. This measure's aim was to decrease marginal tax rates by liberalizing the depreciation of deductions and changing the capital gains rules for real estate.

With the signing of the Recovery Act, real estate became a favored tax shelter. This attracted a healthy amount of capital in the earlier years through syndications. By 1983 it was estimated that, between private placements and public filings, nearly $20 billion was in syndications.

The tax advantages of real estate, however, were not the only factor in flooding the real estate markets with hot money. The money supply had been growing rapidly following the recession, and investors seeking high returns increasingly looked to real estate investments. Funds were pouring in from Europe and Asia.

Deregulation, competition The single most important factor on the capital scene was the dual effects of deregulation and competition on the banking industry. Deregulation of the savings and loan industry allowed the thrifts to lend on real estate. Deregulation measures also raised the amount of deposit insurance to $100,000. This further emboldened the S&Ls in their real estate activities. Many thrifts were bought by development interests and served as personal sources of capital.

Commercial banks were feeling the effects of competition and increased allocations to real estate became the universal strategy for success. Most of the banks' traditional customer base - corporations, eschewed bank loans for debt obtained in the junk bond market, and third-world lending programs that supported the banks in the 1970s - had run their course. Commercial banks turned to real estate lending and leveraged buyout financing to fill the gaps. Banks ramped up their real estate loan programs. From 1980 to 1989, lending went from $100 billion to $350 billion. By the end of the decade, real estate accounted for 35% of commercial banks' total assets.

The influx of money into real estate was creating incredible development activity. Washington, D.C., added 163 million sq. ft.; Los Angeles added 152 million sq. ft.; Dallas office space grew by 246% or 122 million sq. ft.; and Phoenix office inventory exploded by 200%. With each development deal, the house of cards climbed higher.

Real estate depression Highly leveraged, non-recourse capital flowed freely and developers often built whether there was demand for new product or not. As the boom continued and a new supply mounted, the chances of finding tenants at pro-forma rents or buyers at projected sales prices dwindled. The timing for each market was staggered, but a crash was imminent.

There were some key factors that sparked the "Great Real Estate Depression." All of the origins of the boom began to work in reverse. Thefavorable tax advantages created in 1981 were eradicated with the Tax Reform Act of 1986. It eliminated the tax shelter advantages and created a whole separate class of tax disadvantaged income that included rental income. Industry experts estimated that the Reform Act lopped 14% to 20% off the present value of future earnings. Marginal developments were rendered bankrupt. Banks that had played fast and easy with the valuation of collateral were now in deep trouble.

More powerful than the legislative tinkering was that demand was slowing in many markets. Lenders and developers had assumed continued expansion of white-collar jobs, however, the white-collar boom was over.

What stands out about the cycle is that the lending continued. Lenders are humans too and their short-term interests were not aligned with stopping the party. Competition between lenders loosened underwriting and allowed more leverage. Traditionally, bank lenders required a healthy chunk of cash and a list of tenants for construction loans.

The traditional guidelines were gone by the mid-1980s. The speculative loans were 85% leveraged and some banks extended the mini-permanent financing to 5 years after construction. The Federal Reserve acted to tighten credit in 1986, but plans had been made and financing was in place for a lot of new development. The inertia of the entire real estate industry was building in one direction; but, it would take years for the new supply to come to a halt.

The full effects of runaway lending and eroding fundamentals were not fully understood by the end of the decade; but, it was obvious that the tide had changed. The inflation and quick recovery of demand that bailed out the industry in the 1974 to 1975 recession was absent. The savings and loan industry toppled and commercial banks were hurting. In 1990 even conservative insurance companies foreclosed on $3 billion worth of real estate loans. Landlords struggled to keep order by offering concessions, and then rents began to fall. Many property-related firms went bust and developers became property managers.

Foreign ownership scare Foreign investors ran side by side with domestic investors during the 1980s. The United Kingdom, Canada, South Korea and West Germany were big buyers, but most conspicuous were the Japanese. At the height of the decade, foreign ownership of U.S. real estate was 2%, but Japan's entrance into U.S. real estate became a hot topic. In retrospect, the fear of Japanese dominance was overblown.

The Japanese were getting rich from exports to the United States and they wanted more. Armed with low-cost capital and swollen bank accounts, U.S. real estate seemed a good buy. Between 1985 and 1988, Japanese investments in U.S. real estate jumped from $1.5 billion to $43 billion.

The geographical concentration of their investment, California, Hawaii and New York, fueled fears. Estimates had the Japanese owning up to 30% of downtown Los Angeles office space.

High-profile acquisitions compounded fears that the Japanese were buying out America. The Arco Plaza in Los Angeles was purchased for $620 million, and three Manhattan office towers - the Exxon Building for $610 million, 666 Fifth Ave. for $301 million and the Mobil Building for $250 million - all were bought by Japanese investors. Japanese spending peaked with their $1.4 billion stake in Rockefeller Center. As it turned out, the Japanese were the only investors that played the 1980s real estate boom more poorly than U.S. investors.

During the 1980s, the real estate industry rode unbelievable highs and lows. The list of personal and entity-level casualties of the real estate house of cards that was built and toppled during the 1980s was long and distinguished. The decade closed with real estate at its lowest point ever and the national economy was slipping into a deeper recession.