As the nation's economy emerges from recession, the demand for commercial real estate is slowly increasing in many markets. However, the real estate industry will not regain its former vitality until it has reliable sources of capital for purchases, refinancings, improvements, and development.
Where can the real estate industry turn for capital?
Don't look to once-active sources like banks, S&Ls, and insurance companies, which were badly burned in the late 1980s and early 1990s and now face strict regulations regarding real estate loans. Most will avoid commercial real estate for another decade.
Pressures on Pension Funds
If some financial institutions or insurance companies do make real estate loans in the 1990s, they will cautiously demand plenty of equity, preleased buildings, and top-notch locations, thereby shutting out many worthwhile transactions like undervalued or distressed properties.
Pension funds will not come to the rescue, either. In fact, many pension funds will become net sellers - not net buyers - in coming years. Americans are living longer and retiring earlier. In coming years, the baby boomers, whose "leading edge" members turn 46 and 47 this year, will place unprecedented burdens on pension funds.
According to some real estate professionals, the best source of new capital will be offshore foreign investors. Hong Kong and Taiwan buyers have become important players in some markets.
For the past 20 years, foreign investors have came and gone in U.S. real estate markets. After the 1974 oil embargo, Middle Eastern investors provided
conderable capital for sales and development, followed by the Canadians, and later by the Japanese.
Expensive Lessons
All these investors have come to the United States with deep pockets and great expectations, plus the confidence that they could purchase, develop, and manage properties better than their American counterparts. And most of these investors eventually have gone home a lot wiser and poorer.
Today's Hong Kong and Taiwan-based buyers need not suffer large losses like previous offshore investors, provided that they learn from the others' mistakes. If, however, the Hong Kong and Taiwan buyers reduce or halt their investments in the coming years, what offshore investors will take their place?
Not Enough Capital
The Japanese are unlikely participants because they are now mired in recession. The Germans are just as unlikely because they are spending unanticipated billions on the reunification of their nation.
SYNDICATIONS and tenants-turned-owners are new sources.
Besides their come-and-go tendencies, offshore investors simply cannot provide the enormous of capital required for a well-functioning commercial real estate industry. Just to replace the capital introduced by the Japanese in the late 1980s would require over $ 1 0 billion.
Nor do offshore investors typically have long-term interests in American communities at heart. They usually care about profit primarily, not the impact of their investments on our nation's homes, businesses, and economy.
In many markets, three sources may provide the needed funds - in addition to offshore investors.
One source will be office and industrial tenants who decide to buy a building rather than continue to rent space. Earlier this year, for example, Keesal, Young & Logan, a law firm, purchased the high-rise Union Bank Building in downtown Long Beach from Lasalle Partners for $5.4 million. That was reportedly one-fourth the price LaSalle had paid to purchase and renovate the property several years ago.
A second source of capital will be cash-rich immigrants who have settled in many parts of the nation and are now investing in local real estate, particularly in office and industrial properties, smaller shopping centers, hotels, and apartment buildings.
Through their investments and hard work, they have already transformed many communities, particularly in the greater New York City area, South Florida, Southern California, and the San Francisco Bay Area.
As more cash-rich immigrants settle in the United States, and many earlier immigrant arrivals accumulate wealth, their capital will have a greater impact on many of the nation's real estate markets, not only in established communities like Chinatown in New York or Koreatown in Los Angeles but also in other well-regarded or promising locations throughout the nation.
Tax Inducements
A third source of real estate capital, probably the largest of all, will be syndications. Although the Clinton administration will impose tax increases on the well-to-do, it is also discussing significant changes in the tax code, such as passive loss provisions and deferral of federal taxes on income realized upon the cancellation of certain real estate debt.
If enacted, these measures will once again make real estate investments more attractive as well as reduce the effective high-income tax rates.
In essence, the Clinton administration might reintroduce same of the provisions that created the tax shelter business of the early 1960s. These measures will encourage people to form syndications and invest capital in real estate in order to reduce their taxes.
The increased real estate activity, if historical patterns hold true, will also have a healthy multiplier effect on the economy, encouraging investment in facilities and equipment and creating jobs.
