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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Austin Business Journal – by Greg Barr

The Texas economy is predicted to begin a slow, steady recovery in 2010, according to an economic report released Monday.

After a small contraction in 2009, the state’s gross domestic product is expected to increase by 1.7 percent in 2010, aided in part by a surge in home sales, according to economists with BBVA Compass. The GDP of the entire country, by contrast, is predicted to increase by only 0.2 percent next year.

The bank’s U.S. Regional Watch third-quarter report released Monday, said that although the worst of the economic crisis has passed, fiscal pressures will affect some states more than others and dictate the pace of their recovery.

Though 48 states predicted budget shortfalls at the beginning of the year, with Texas projecting a 9.5 percent deficit, it is the only state among the seven Sun Belt states covered by BBVA Compass to forecast a balanced budget in 2010.

“Texas has fared the best with revenue growth exceeding the U.S. average,” the report said. “The higher than average growth throughout 2008 could be one of the reasons that Texas is better positioned with a smaller than average budget gap going into FY2010 and no expected gap for FY2011.”

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Washington, September 24, 2009

Existing-home sales in August gave back some of their strong gain in July but remain above year-ago levels, according to the National Association of Realtors®.

Existing-home sales – including single-family, townhomes, condominiums and co-ops – declined 2.7 percent to a seasonally adjusted annual rate¹ of 5.10 million units in August from a pace of 5.24 million in July, but remain 3.4 percent above the 4.93 million-unit level in August 2008. In the previous four months, sales had risen a total of 15.2 percent.

Lawrence Yun, NAR chief economist, said the tax credit is working. “Home sales retrenched from a very strong improvement in July but continue to be much higher than before the stimulus. The first-time buyer tax credit is having the intended impact of bringing buyers into the market, allowing them to take advantage of very favorable affordability conditions,” he said. “Some of the give-back in closed sales appears to result from rising numbers of contracts entering the system, with some fallouts and a backlog contributing to a longer closing process, but the decline demonstrates we can’t take a housing rebound for granted.”

According to Freddie Mac, the national average commitment rate for a 30-year, conventional, fixed-rate mortgage fell to 5.19 percent in August from 5.22 percent in July; the rate was 6.48 percent in August 2008.

An NAR practitioner survey shows first-time buyers purchased 30 percent of homes in August, and that distressed homes accounted for 31 percent of transactions; both were unchanged from July.

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Total housing inventory at the end of August fell 10.8 percent to 3.62 million existing homes available for sale, which represents an 8.5-month supply² at the current sales pace, down from a 9.3-month supply in July. Unsold inventory totals are 16.4 percent lower than a year ago.

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