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overall development cost. The rules had most definitely changed. Buyers were so excited by real estate (usually the loans were accompanied by equity participations) that they often forgot even the most rudimentary valuation standards.

The equity investor found a multitude of other advantages, including tax write-offs and leverage. Say, for example, that I bought a property with an 80% mortgage. Suppose further that the property doubled after five years-conservative in the eighties. I would have sixfolded, not doubled my money, since I had put up only 20% of the price. Because interest, depreciation, and other expenses were tax deductible, I could write them off against other income, thus minimizing their impact. Not a bad deal.

When commercial real estate appreciated at a 15% clip through the early eighties, everyone wanted on the bandwagon. Pension consultants urged their major clients to jump in. A large number of the decisions were based on modern portfolio theory. After all, here was a place where they could make 15% or higher returns. Much more than the stock market. Better yet, it added diversification and lowered beta, which, according to their efficient market training, made the retums greater still.* Large pension funds placed major money in questionable ventures, many near the top.

Consultants often urged their clients to invest with managers who had hot hands. Here we see a bit of the bizarre. Unlike the stock market, which appraises the value of a stock on every trade, the real estate manager was allowed to appraise his own properties. He simply assigned a value to the clients property at years end. That he took 20% of the increase in appraisal price, which could mn up to 30% or 40% of the propertys value, or that scads of new money swarmed to him because of the fabulous retums-created with the stroke of a pen-didnt seem to impugn his impartiality. Not unlike declaring four aces and raking in the pot without a showdown. As a money manager, Im a little envious. Here is a market that a deserving manager should find only in paradise.

Does this sound zany? Of course it does. Nonetheless, it was done by many of the largest corporate pension funds, on the advice of some of the most blue-chip consultants in the country. Once again, a crowd mesmerized by the image of limitless wealth threw caution to the winds and headed for the cliff.

In Japan, although property prices had increased ten times in a few years, the major banks loaned money at approximately 100% of a proposed projects value. After all, believed investors in the late 1980s, Japanese real estate, like Japanese stocks, could never go down. It was little different in the West. Commercial space for rent expanded enor-



overall development cost. The rules had most definitely changed. Buyers were so excited by real estate (usually the loans were accompanied by equity participations) that they often forgot even the most rudimentary valuation standards.

The equity investor found a multitude of other advantages, including tax write-offs and leverage. Say, for example, that I bought a property with an 80% mortgage. Suppose further that the property doubled after five years-conservative in the eighties. I would have sixfolded, not doubled my money, since I had put up only 20% of the price. Because interest, depreciation, and other expenses were tax deductible, I could write them off against other income, thus minimizing their impact. Not a bad deal.

When commercial real estate appreciated at a 15% clip through the early eighties, everyone wanted on the bandwagon. Pension consultants urged their major chents to jump in. A large number of the decisions were based on modem portfolio theory. After all, here was a place where they could make 15% or higher retums. Much more than the stock market. Better yet, it added diversification and lowered beta, which, according to their efficient market training, made the retums greater still. Large pension funds placed major money in questionable ventures, many near the top.

Consultants often urged their clients to invest with managers who had hot hands. Here we see a bit of the bizarre. Unlike the stock market, which appraises the value of a stock on every trade, the real estate manager was allowed to appraise his own properties. He simply assigned a value to the clients property at years end. That he took 20% of the increase in appraisal price, which could run up to 30% or 40% of the propertys value, or that scads of new money swarmed to him because of the fabulous retums-created with the stroke of a pen-didnt seem to impugn his impartiality. Not unlike declaring four aces and raking in the pot without a showdown. As a money manager, Im a little envious. Here is a market that a deserving manager should find only in paradise.

Does this sound zany? Of course it does. Nonetheless, it was done by many of the largest corporate pension funds, on the advice of some of the most blue-chip consultants in the country. Once again, a crowd mesmerized by the image of limidess wealth threw caution to the winds and headed for the cliff.

In Japan, although property prices had increased ten times in a few years, the major banks loaned money at approximately 100% of a proposed projects value. After all, believed investors in the late 1980s, Japanese real estate, like Japanese stocks, could never go down. It was little different in the West. Commercial space for rent expanded enor-



mously. The U.S. Govemment reported in early 1996 that retail space, for example, had doubled since 1988.

The influx of money fueled constmction. Developers would build and purchasers buy almost anything. Partnerships popped up like mushrooms. Like the Florida Land Bubble of the mid-twenties, which sold swampland, often under water, almost any project could be sold. Almost anything, that is. When promoters peddled projects that even their normally frenzied buyers wouldnt touch, there was always a brokerage house in the wings with clients clamoring to buy into the partnership. These deals really smelled. Fortunately for the clients, the large markups and poor quality of some of them forced the SEC to step in. The brokerage houses ultimately ate billions of dollars in losses.

"Just how did the commercial real estate mother lode of the last decade tum into the fools gold of the 1990s?" asked a financial publication. Demand for commercial real estate, partially created by expanding intemational trade, banking, and brokerage operations in the seventies and early eighties, accelerated property appreciation.

Ironically, as loan officers scrambled to acquire property, the same banks and insurance companies were sharply reducing their space requirements. From 1980 to mid-1992, the office vacancy rate in Manhattan jumped from 2.9% to 17%, in London from 2% to 20%, and in Toronto from 1.8% to over 13%. The 1987 stock market crash launched a worldwide retrenchment in financial services. Though the stock market subsequently tripled from its previous high, jobs had declined 10% from their peak.

The end was devastating, not only for the newly rich developers with their recently acquired Gulf Streams, yachts, or trophy wives, but for hundreds of thousands who had their savings in this sector. The marvelous leverage that enriched investors on the way up, bankmpted them on the way down. A 50% drop, with 20% equity and 80% borrowed funds, resulted in a 250% loss. If the investor had guaranteed payment-good-bye. Even some of the shrewdest intemational developers went under; the Reichman Brothers of Canada lost billions on the Canary Wharf Project in London. "The Donald" filed Chapter 11 on the Tmmp Taj Mahal Casino to avoid personal bankmptcy proceedings. As one periodical put it, "Not many people realize how stunningly big the commercial real estate debacle is."* The savings and loan industry was devastated. The Govemment had to form the Resolution Tmst to acquire the assets of insolvent S&Ls, which it then sold at 50% or less of the price on the books. By mid-1992, an estimated one trillion dollars was lost in the U.S. alone-more than the cost of the 1987 crash. Worldwide, it may have been many times this figure.



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