We invite readers to take a trip in NREI's time machine, traveling back over five decades of commercial real estate finance — from the development of REITs to the collapse of CDOs.
Developers begin ramping up urban renewal projects. The inaugural issue of NREI focuses on New York City and its issues with Title I, a controversial, billion-dollar federal program and part of the National Housing Act of 1949, designed to encourage private capital to help clear out city slums. The idea was that cities would condemn slums and turn them over to private developers for the value of the cleared land.
“The temptation is obvious,” wrote NREI contributor Fred Cook in the September issue of 1959. “As long as the new landlord could maintain the status quo, he had acquired a profitable slum at bargain-basement prices, and the longer he could keep it the way it was, the larger the fortune he could collect in rentals before he had to demolish and rebuild.”
Detroit is hailed as a “city of change.” In a February 1960 area review, Detroit News reporter Carl Konzelman writes that “rapid diversification on an incredibly large scale is meeting successfully the challenge of the auto industry's decentralization program.”
According to the Michigan Economic Development Department, at least 304 industrial expansion projects were announced in 173 Michigan communities in 1959.
REITs get a birth certificate. Congress passes the Real Estate Investment Trust Act of 1960 under President Dwight D. Eisenhower to provide funds to the mortgage market.
REITs suffer a decline amid severe recession. In the spring of 1975, G.N. Buffington, then president of the National Association of Real Estate Investment Trusts tells a group of bankers, “The danger is that with one or two more [REIT] bankruptcy filings, the stigma of bankruptcy might be lessened, making this route more attractive than other choices.”
For bankers managing real estate or projects under construction, Buffington recommends “informal workouts conducted by experienced management without the pressure of time or the inflexibility of court approval and administration.”
President Jimmy Carter calls for a residential building boom. Washington Wire columnist Barry G. Jacobs writes in the January 1977 issue, “Carter, noting the high unemployment in the construction industry and the continuing housing problems of low-income families, has called for an increase in housing starts to a record 2.5 million a year.”
Carter's policy, The Community Reinvestment Act, encourages banks to grant loans to people with low income and little credit. Decades later in 2007 and 2008, the Georgia president is blamed for planting the seeds of the subprime housing crisis.
Lenders accept optimistic appraisals and grant loans based on future income. In the August 1977 pages of NREI, Citibank assistant vice president Richard A. Lex says the basis of more than 30% of problem real estate loans can be attributed to lenders who seek out “a fictitious value” and who rely too heavily on projections for real estate developments that “purport to accurately project sales activity for the next 15 to 25 years.”
The Tax Reform Act of 1986 is passed. The act allows REITs not only to own property, but also to operate and manage income-producing commercial real estate.
The Dow Jones Industrial Average loses 22.2% of its value on Oct. 19, 1987. Recovery of the market begins the next day. However, it takes two years to completely recoup the losses of Black Monday.
The Resolution Trust Corp. (RTC) is created by Congress on Aug. 9, 1989. The purpose of the government-owned asset management company is to dispose of primarily commercial real estate assets held by failing savings and loan companies. By 1995, the RTC has closed or resolved $394 billion in total assets.
Consolidation is the watchword for hotels. In the December 1987 issue, Laventhol & Horwath, a Philadelphia-based consulting and accounting firm, estimates that the 25 largest hotel companies control about 50% of all rooms in the U.S. Roger J. Dow, then vice president of sales and marketing services at Marriott Hotels and Resorts forecasts that hotel companies will consolidate into three or four big players, along with smaller-segment operators.
Corporations cash in on real estate through sale/leasebacks. During the recession of the early 1990s, many companies sell their commercial real estate assets to raise capital and improve the health of their balance sheets.
In May 1992, NREI reports that the Marriott Corp. sold 13 Courtyard by Marriott hotels for $146 million to a group of insurance and financial companies. The hotelier took out a long-term lease agreement in order to operate the properties while sharing a portion of the operating income with the new landlord.
Commercial mortgage-backed securities take a seat at the finance table. In part fueled by the RTC and its need to dispose of large commercial holdings, CMBS volume soars to $20 billion by '95, up from $1.6 billion in '90.
REITs make a comeback. Following the S&L crisis of the late 1980s, REITs are back in vogue with the aid of the Tax Reform Act of 1986. In the January 1998 issue of NREI, Dr. Peter Linneman of the Wharton Real Estate Department advises investors about the advantages of REITs, including “lower-cost and less restricted debt capital; equity capital with a lower risk premium due to regular disclosure; lower transaction costs per dollar raised; larger margins on revenue; a higher valuation of acquisition assets relative to competitors with higher capital costs; and great operating efficiencies.”
Commercial real estate collateralized debt obligations (CDO) thrive — then die. One of Wall Street's many complex investment vehicles, CDOs are a credit product that pool other high-risk, high-yield assets.
Unlike CMBS, which are backed by fixed pools of real estate mortgages, CDOs permit trading of the underlying assets and are based on the cash flows of those assets.
The first CDO was issued in 1987. By 2006, issuance of commercial real estate CDOs reaches $36 billion, more than double the issuance in 2005. In the fall of 2007, issuance drops by 22% to $28.6 billion as the credit crisis begins to unfold.
Investor fears of paper losses cause the securities market to freeze up. Mark-to-market, an accounting rule that places a value on financial instruments held in portfolios based on the current market price, is hotly debated.
“Public companies and other large institutions that report to investors typically value their portfolios quarterly based on market rates,” writes NREI contributor Matt Hudgins in June 2008. “That means a CMBS bond that generates a return of 18% is considered less valuable if similar bonds down the road are priced to pay 20%.”
Despite miniscule CMBS delinquencies, through the first half of 2008, issuance drops to $12.1 billion, down 91% from the same period in 2007.