The '90's Real Estate Crash vs. Today's Meltdown

A friend of mine, Steve Felix, who is the most networked person in the real estate industry, a great guy and a talented rock guitarist, publishes a newsletter every week. The newsletter, On the Road with Steve Felix, gives his and other's insights, shares nuggets from conferences and provides great recommendations for restaurants, music and hotels around the world.

Last week, Steve asked about 30 of us to provide our comments on comparing the real estate crash of today with the debacle in the 1990's. The response was excellent which is a tribute to Steve, as well as his readers. Today, Steve published the unedited version of all the comments. In the interest of trying of trying to keep the summary as brief as possible, I culled the best of the comments for your review and comments. How would you compare what we experienced in the '90's with what we are experiencing today?

1. First, this time around--the speed with which the market came apart was unprecedented. The impact is much more personal this time. The impact is/was more widespread. Then the problem was on the front page of the business section. This time it’s on the front page of everything!

2. Second, the economy is not holding up as it did the last time around. In short, the economic fundamentals are much weaker this time and will be much slower to recover, and rents will be a long time recovering as a result, both because some of the job loss is never coming back and because the credit market dysfunctional will continue for quite some time. We have yet to see the worst of it, generally speaking, and there will be many a false dawn before we see the real McCoy.

3. Both eras experienced difficult fundamentals (today – more of a demand problem, them – more of an oversupply problem), but overall the enormity of the situation is a lot bigger and, from a value erosion perspective, much worse today than 15-18 years ago. The recovery will be slower this time around – if then it took 5 years this time it will be about 7 years (8/2007 until 2014).

4. Baby boomers were relatively young and resilient. Better able to weather the storm and rebound than today.

5. In the RTC days there was oversupply of product, this time around there is no over building but rather demand destruction-which still gets you to oversupply of all property types.

6. Lastly, the rigid debt structure of CMBS is untested and did not exist the last time around--we are all going by Braille on this and who knows where it will take us and the real estate industry.

7. The biggest difference I see is in the RTC days the banks wasted no time in taking back assets and making them REO's and the RTC just moved them.

8. Past was FAST! The pace was fantastic! The government facilitated a quick, catastrophic, over the top write down, taking many lenders and owners down and out. Smart money showed up hungry and underwrote in windowless rooms with cadres of kids and elders hand compiling data - ah, the war room! Didn’t have to be very right to win. It was all about courage. Successfully got the junk cleaned up. Constituted perhaps the greatest involuntary wealth transfer ever on the planet. Was it fair? No. Was it effective? Very.

9. Today, OMG how slow! Deal by deal, discount by discount. As long as the lenders can argue they are solvent nuttin’ needs to move. All evidence supports a slow recovery. If the economy is strong enough, “Pretend and Extend” will stop. If the economy has a gradual recovery, it won’t for a while. Therefore, the Congress has turned Citibank, B of A etc. into RTC II's. Government funds the banks, they extend and we push this mess out three years- but never resolve. Smells like Japan! As I have been telling our investors - the banks made stupid decisions when it was good and they have swung the other way and are making equally stupid decisions when it is bad - they are taking 0% risk and demanding unreasonable terms.

10.This Congress and our new President are behaving in a way that screams- "I will not be associated with the fire sale of real estate assets held by banks" and attributed to the private equity raid of the candy store at 10 cents on the dollar. The politics and egos and stopping them from initiating the very cleansing mechanism we need.

11.But in fact it all needs to move! Would be nice to see the government act a bit more authoritatively – in terms of forcing revaluations and shutting down the insolvent players, especially now that the critical stage seems past. Stop propping and start popping.

12.To that point the drop in values happened in cyber time- very fast vs. taking years to get to peak to trough. Though some may drop further the decline has been rapid- and widespread. Lastly this has impacted every market and every property type vs. RTC days when some markets/assets fared ok.

13.Commercial Real Estate 1986-1994 vs. 2008-

Similarities

a) Plentiful capital (both debt and equity).

b) Deflation in property values followed extended period of rapid increases based upon capitalization/yield rate compression (i.e., without corresponding increases in financial performance).

c) Extremely lax underwriting by lenders.

Differences

a) Prior downturn due largely to massive additions to supply coupled with disadvantageous changes in federal tax law; current problems exacerbated by sharp contractions in demand due to deep recession in the overall economy.

b) Much greater portion of capital came from public markets recently than in the prior downturn; spurious ratings of CMBS played a significant role in current situation.

c) The OCC and FDIC are now more knowledgeable regarding distressed commercial real estate than in the prior crash and thus should be more adept in assisting in market-clearing activities.

d) Recovery from the current difficulties is likely to be more prolonged due to a) the forcast slower recovery of the overall economy; b) higher interest rates caused by historic borrowing by the federal government; and c) the likelihood of significantly higher federal income tax burdens on both individuals and businesses.

14.Some thoughts:

a) Liquidity: Then-Very little; Now-Plentiful capital is available

b) Supply/Demand: Then-Too much overbuilding: Now-Overbuilding not the issue

c) Banks as lenders: Then-Major supplier of capital; Now-Banks only 30% of lending; many more non-bank players

d) Deal Complexity: Then-Could be but most deals had few participants; Now-Very complicated capital stacks; many deals with 15+ layers

e) Gov't Intervention: Then-Some Heavy; Now Propped up many financial institutions

f) Willingness to Foreclose: Then-Many had large workout reluctance; Now-Willing to have & asset management teams borrower run asset due to local knowledge and experience.

g) Workout Mechanisms: Then-Covered in loan docs; Now-Mechanisms do not work for REMICS. All are having great difficulty working out due to complexity

h) Workout Experience: Then-Many seasoned pros that had been thru 1974 down markets restructures. Now-Very little experience

i) Special Servicers: Then-Limited role: Now-Not set up for number & complexity of deals

j) j. Global Issues: Then-Very little; Now-Deals and sources of capital global in nature

15.Greed and fear are part of our sustainable, capitalistic society and both of these emotions played a role then - S & L Bailout/RTC Days, and now - Financial Bailout. To compare the two “crises” is helpful if it serves to make us wiser. And being wiser is the key! Notice I didn’t’ say smarter. Wise means finding a balance of greed and fear, and right and wrong. No regulation will make you wiser.

16.Today, real estate is ridiculously mainstream, and investors' willingness to invest anywhere, anyhow, at any level of the capital structure continues to amaze me. I'm no longer naive (or with hair), and remain skeptical that we will learn anything from this crisis. Few innovations will come from it (nothing is forcing the innovation this time), the banks will pretend they don't have massive losses long enough that things will inevitably improve (and thus justify their inaction), and we will soon return to frenzied bidding wars to buy mediocre assets at 4.5% yields (at least in Europe). Unlike the last time, when it took almost eight years for investors to re-dip their toes, I predict the wall of cash returns much sooner than is financially justified, which will of course bailout all the silly projections that underlie these future buys. And on we go.

17. In short, we were in “shit” back then. Today, we are in “deep shit.”

A couple of final thoughts:

Over twenty people responded to Steve’s call for comments and observations. Their observations were very astute, realistic and uniform. The scary part: Everyone that responded with their observations, which more insightful that I have one government official, political or bureaucrat, Fed, FDIC, you name it. This is a sad commentary and will, unfortunately, prolong the how long it takes to work out of this mess.

Finally, isn't it a sad commentary that it's been eight years since the World Trade Center event and there is still nothing built...just talk, lawsuits, politics and bullshit? Everyone involved should be ashamed of himself or herself.