The real estate industry burned to the ground during the prior decade, so the slogans of the early-1990s were "Survive 'til '95" and "Make do 'til 2002." Few could envision the regeneration that was to take place in the decade to come. Real estate markets have experienced a sustained recovery during the 1990s. The longest economic expansion in our history has produced steady demand for real estate, and we are now faced with the overbuilding concerns that follow prosperity in our industry.
More interesting than surging real estate fundamentals, which have become routine over the years, is the altered complexion of the real estate industry. Many of the changes may turn out to be cyclical, such as ownership or sources of capital or financial structures. In other respects, it is difficult to look forward to a real estate industry that closely resembles the past.
Change has come slowly, but it appears to have hit the point of no return in many respects. The increased presence of Wall Street and the capital markets, more sophisticated use of computer technology and information, and more efficient markets seem immutable at the end of the 1990s.
The desperate times created by the 1980s real estate depression has forced many of these changes. Desperate times often incite incredible waves of change and progress. This is certainly true of the real estate industry during the past decade.
The real estate bust had traditional sources of real estate equity and debt sidelined at the start of the decade. Risk-averse sources like insurance companies and pension funds licked their wounds along with most private financiers after the crash. With so many attractive buying opportunities in the badly burned market, the aggressive, opportunistic world of Wall Street (the big story of the decade) made its grand entrance.
RTC strategy works...for a price Thrift insolvency caused by the Depression was severe enough for the Federal government to step in. In 1989, Congress formed the Resolution Trust Corporation (RTC) to bail out or otherwise resolve the insolvency of more than 750 failed savings and loan associations. The aim was clear: Sell assets of the failed S&Ls and pay insured depositors.
The task was complete by early 1996 and the RTC program was shut down. Of the $456 billion in assets slated for liquidation, $395 billion was recouped. The cost of paying off depositors and administering the sales of assets was $180 billion, or $1,176 per taxpayer.
Positions on the effectiveness of the RTC vary. Susan Hudson-Wilson, founder and president of Boston-based Property & Portfolio Research, sums up the effort. "The RTC was the greatest and most unfair transfer of wealth that has ever taken place in this country - perhaps the whole world. Great wealth was literally stolen from people and transferred to a group of cash-rich 'tide-riders'. I am happy for those who were able to take advantage of the 'Great Exchange' (to quote Peter Aldrich), but I do have sympathy for those who lost their assets amidst the frenzy."
The meeting of a bureaucratic government-run entity and the most savvy real estate investors in the world is bound to produce some inequities. The RTC decided on an aggressive disposition strategy, and the unloading of recovered assets into a market with scarce capital likely intensified the downward spiral. Assets were snapped up at incredibly deep discounts.
Fair or not, the RTC was one of the largest transfers of wealth in history, and it provided a foundation, for the rest of the industry to push off of during the rest of the decade.
Wall Street jumps in Wall Street's influence jump-started the real estate market out of its early-1990s doldrums and contributed greatly to the frenzy of acquisition and development activity towards the closing years of the decade. Every property type was affected. Traditional lenders and investors were incredibly active too, but Wall Street vulture funds, REITs and the burgeoning CMBS market provided the spark for the latest real estate expansion.
The growth of REITs during the 1990s was unprecedented and probably put the asset class on the broader investment map for good. Cash-poor developers and investors at the turn of the 1990s had no other options other than to turn to the equity markets. According to the National Association of Real Estate Investment Trusts (NAREIT), in 1990 there were 119 REITs with a total market capitalization of $8.7 billion. At the time of this writing there are 211 REITs with a market cap of just under $140 billion. This is still a small slice of the overall ownership of total real estate assets, but the effects of the emergence of REITs has been profound. More importantly, many of the changes are here to stay: more information, more liquidity, both in REITs and the underlying assets, and the red flag that is provided by falling stock prices.
The 1990s REIT free-for-all began in 1991 with Merrill Lynch's successful $130 million initial offering for Kimco Realty Corp. By 1993, REIT offerings hit record highs with more than 50 REITs going public, raising better than $9 billion. As the decade progressed, REIT market caps hit what most experts consider critical mass. Countless old-guard family real estate ventures teamed up with REITs.
The big players best illustrate the essence of the REIT movement of the 1990s. Richard E. Rainwater put together Crescent Real Estate Equities, a mammoth REIT with a diverse collection of assets - cold storage facilities, a stake in a basketball team, resorts and medical facilities as well as huge swaths of office property in Houston and Dallas. William Sanders' quiet assemblage of a massive conglomeration of apartment, industrial and hotel REITs organized under a public corporation, Security Capital. Vornado Realty Trust's Steven Roth lured star dealmaker Michael Fascitelli with a $50 million compensation package to raid markets for acquisitions.
And, of course, there was Barry Sternlicht's hotel industry coup. Fresh off a tidy 200% return on money invested in Sam Zell's apartment REIT before it went public, Sternlicht made the buy of the century. His acquisition of Hotel Properties Trust in 1995 provided the paired-share REIT status that allowed the company to both own and manage hotels. Sternlicht and Starwood gobbled up hotels, hotel portfolios and hotel companies at breakneck pace through the 1990s.
With critical mass attained, REITs continued to expand rapidly to keep up with the competition. To keep up with analysts' growth expectations, REITs went on an epic buying spree. By 1996, equity investments held by REITs had ballooned from 3% to 29% of the total market from 1990 to 1996. Lofty acquisition prices raised eyebrows. Boston Properties Inc.'s acquisition of the Embarcadero Center in San Francisco and Equity Properties Trust's $108.5 million acquisition of 100 Summer Street in Boston were considered especially rich.
The ownership of REIT shares, a crucial measure for the endurance of the asset class, also shifted in this time. By 1990, 90% of all REIT shares were owned by retail investors. As the decade progressed and the perceived risks of REIT investment ebbed, institutional investors jumped on board and now hold the majority of REIT stock.
The 1990s saw REITs rise, dominate and then pull back a bit as stock prices weakened. Most industry watchers predict a continuing trend towards securitization of the nation's real estate assets. The pace and magnitude of the shift from privately held real estate during the 1990s will certainly be viewed as the flashpoint of this trend.
The 1990s also saw the CMBS market leap to life and earn a top spot in the history of real estate finance. Distributing real estate lending risk by securitizing loans and offering them to investors has changed the face of real estate finance. This process has developed rapidly, but is still developing and maturing. Liquidity in junior tranches has hit bumps in the road and shown that the pricing of the financing was perhaps too aggressive.
Better data and information systems to improve underwriting for origination of the loans and the investment in CMBS offerings will continue to improve the outlook for the process. The current slowdown following last year's capital markets volatility is another growing pain in the maturation of this relatively new and exciting trend in real estate finance.
CMBS issuance in 1990 was $4.8 million. Issuance soared as the structuring and delivery of this vehicle took shape, and starving borrowers took notice. Ethan Penner and the Nomura Capital blazed the trail and the industry grew. Strong investment activity supported liquidity in the secondary market and the industry began hitting on all cylinders by the mid-1990s.
By 1997, issuance had reached a record $44 billion, and half way through 1998 issuance was on pace to beat the previous year. Competition between conduit lenders, however, had created unrealistic spreads by the last quarter of 1998, and the market went through a dislocation when incredibly thin spreads exploded in reaction to negativein the Russian debt markets.
Wall Street has been heralded as having added a measure of discipline to a traditionally freewheeling industry, and as the decade closes, we may be seeing some proof of that claim. The capital markets went haywire in late-1998, creating a bump in the road for what was becoming a scary CMBS market. Spreads were wafer thin and way out of whack. In the turmoil that followed, it is possible that the market learned a thing or two about pricing. This will likely be remembered as a healthy development in the long run.
REITs, too, have fallen on hard times. REITs were awash in capital for much of the decade. The money was burning holes in a lot of pockets, and REITs were throwing some pretty tidy sums at properties as well as diving headlong into the development business. Overbuilding in key markets and the rising risk of a national economic slowdown have helped take some of the wind out of the REIT sails. This too, will prove to be a long-term benefit for the overall real estate market.
Consolidation to the fore Consolidation and mergers of real estate entities - both public and private - were commonplace during the 1990s. Local firms reacting to the increasingly national scope of real estate (another "-ization" = nationalization) married to firms with regional scope. Niche players became niche divisions of larger companies.companies, information providers, REITs and Wall Street firms were all active in this trend.
REITs consolidated at breakneck speed with the hope of boosting funds from operations (FFO). Some of the mergers were huge - Equity Residential augmented smaller entity and portfolio acquisitions with the Evans Withycombe Residential merger for $1.1 billion in equity and debt; Starwood Hotels & Resorts Worldwide merged with ITT Corp. in a $14.6 billion transaction; Simon Property Group and DeBartolo Realty merged to form the largest REIT at the time with a market cap of $3.1 billion.
Information Age and research Sparked by the lean times of the early-1990s, increased exposure to Wall Street, and the better use of technology, the availability and use of real estate data and information has exploded during this decade. "The most important driver of the evolution of information and its use was the Great Real Estate Depression," says Susan Hudson-Wilson. "When you have a crisis of that magnitude, it is a requirement that you use as many weapons to protect yourself as possible. Great distress and stress really motivates change."
The influence of the capital markets has also driven the trend for more and higher quality research. "The capital markets-based investors are more dispassionate and are more willing to be exposed to, and use, different views on markets. As more Wall Street and less Main Street dominates capital flows, research is increasingly and more effectively used."
Useful, unbiased commercial real estate data has been largely absent from the real estate industry. What information existed was considered highly proprietary. "Until recently, it was the information itself that created value for real estate companies," says Hudson-Wilson. "Now data is becoming ubiquitous. The value added for real estate companies now comes from what they do with it."
Real estate information, flush with capital from initial public offer companies, made significant steps in building useful databases of information by buying regional data providers during the 1990s. COMPS.COM has made great strides in providing commercial sales transactions through an Internet-based warehousing platform. Real estate decision-makers can now access a database of confirmed transactions for nine property types in 40 major metropolitan areas. CoStar Group, which for most of the 1990s was known as RIG, absorbed Jameson and LeaseTrend and made its entrance into numerous new markets. It now tracks more than 3 billion sq. ft. of industrial, office and flex space, suite-by-suite, down to blocks of 100 sq. ft. The firm also tracks more than 310,000 tenants.
Property & Portfolio Research (PPR) has provided top-down research for large institutional investors since 1994. PPR takes a quantitative approach to real estate investment and applies modern financial theory to design appropriate real estate portfolios and counts some of the most prestigious and powerful investment banks, pension funds, insurance companies and investment advisers as clients. Market information is available for free now, too. Relatively detailed reports from major brokerage firms are available at the simple click of a mouse.
Better information has already had a significant effect on how the industry works. "We do have much better information now and some are using it," says Hudson-Wilson. "A down cycle like we had last time is not possible with the level of information we have now. The ultimate effect of modern real estate research will be to put real estate on the same footing as other investments. We will be able to discuss real estate in the same language as strategists and analysts of other assets."