Commercial real estate execs discuss the '90-'91 downturn and how the latest crash compares.
Tanya Bell is vice president of development and acquisitions and manages the residential portfolio of St. Paul-based Wellington Management Inc. She joined the firm in 1999 after serving as managing director of the Twin Cities office of CB Richard Ellis.
"The real estate industry is clearly in its worst condition since the 1930s."
Thomas Borman, Minnesota Commerce
Commissioner, before U.S. Congress, 1991
The early 1990s generally have been considered a low water mark for the commercial real estate business. The industry here and nationwide was dealing with the consequences of imprudent real estate lending and a building boom that put scores of new buildings on the market just as the economy declined.
The federal government stepped in, creating the Resolution Trust Corp., to try to clean up the mess created by the industry and the failed savings and loans that had loaned them money. But the fix wasn't in time for some companies, including national firms like Trammell Crow, Vantage and Lincoln Properties that either went out of business, or left the Twin Cities market.
In the Twin Cities the downturn was felt mostly in the office market, and was especially apparent in downtown Minneapolis, which had four new major office buildings -- LaSalle Plaza, AT&T Tower, Dain Plaza and First Bank Place that it had to fill. The average office vacancy rate here jumped to more than 20 percent.
That's about where it is again today. Meanwhile Opus Corp. has dismantled itself and other longtime commercial developers and brokers are struggling. So for the commercial real estate industry, is this recession as bad as the early 1990s?
We asked some longtime executives their views on the two down cycles, and excerpts from their comments are inside.
Q In general how does this commercial real estate downturn compare with the one in the early 1990s?
Bell: In 1990-91 the market delivered excess supply in new construction just as the economy took a turn and the savings and loan crisis took its course. In 1990 supply was a big culprit. Today's downturn is much more demand driven -- the shrinking economy. There was also a credit crunch at that time, but today's financial challenges are much more widespread. The underlying issues in the financial markets are deeper and more devastating.
Peyton: We did not have overbuilding this time, but you could argue about whether the lending was too aggressive. Now the biggest challenge is that the capital is just not out there to lend. Ownership structures are more fiscally sound than the were in the 1990s -- the industry then was geographically segmented and not very consolidated. With the rise of REIT [real estate investment trusts] and institutional investors, properties for the most part are in the hands of better-capitalized owners today.
Crowley: These current events are more violent and unknowing than anything the real estate industry has ever endured. There seems to be money in the banking system, but there's a cloud of doubt that there could be governmental rules that would compromise good as well as marginal banks. So all banks are cautious to a fault, and real estate and now other industries have ground to a halt.
Q What about your own business? How have you been affected compared with the downturn in the early 1990s?
Pobuda: I was at Trammell Crow in 1990 when the downturn hit. As a larger national company, it had to deal with multiple issues -- not only the property issues but people issues -- you're talking about careers and lives. The beauty of a boutique is that you can stay solidly focused on the properties.
McHale: Starting in 1989 we went on a retail building boom for the next 15 years in the Twin Cities. We had major growth by Target. Wal-Mart came into town. Cub and Rainbow had major expansion. All the junior anchors started expanding. Franchising was booming. The Mall of America opened. Now everything has just stopped. We started pulling back about three years ago. We couldn't do business the way we had done it -- getting anchor commitments locked in and enough pre-leasing. We would have had to become more speculative and elected not to. Right now we're absorbing existing space. We haven't broken ground on anything in almost two years and expect it'll probably be another year before we do.
Peyton: We were a $350 million brokerage services company across the country in the early 1990s. Today we have more business lines that don't rise and fall the same way a brokerage does. Some have been barely affected. Our valuation, assets services and facilities management businesses are still good.
Bell: I was a real estate broker in the early 1990s, so the impact then was less commissionable activity. In the asset management world, less new activity does not mean less work, it actually means you work harder to keep your properties performing and meeting the needs of your tenants. The actual affect on us as developers/investors has been similar to 1990-91. We have turned more attention towards acquisitions of existing property and less to new development.
Crowley: Our ongoing production and generation of new loans are seriously affected by this downturn. There is an enormous backlog of business to be done. Whenever this logjam breaks I want to be around for one more feeding frenzy.
Q How did the industry recover back then? Have we hit the bottom this time, and what will it take to recover?
Pobuda: Job growth is what always brings us back. Also, back then the government created the Resolution Trust Corp. [RTC] as a clearinghouse for bad loans. There was reckoning by the government of the need to clear the system. In this downturn there are lots of banks on the watch list, but the government hasn't felt compelled to create a vehicle similar to the RTC. Banks are renewing, restructuring loans and hoping for better times. I don't think it's hit bottom yet. Vacancy rates are going to continue to climb over the next six to 12 months. Property values, which have fallen from 25 percent to 40 percent, hopefully are approaching a bottom but that depends on the impact of foreclosed property sales.
Peyton: Right now there's a lot of capital sitting on the sidelines. There needs to be benchmark transactions that people can price off of. They're starting to occur in the single-family residential subdivided land business. We've seen private capital coming in, but we haven't seen a lot of institutional buying. It's because the debt capital isn't out in the marketplace.
McHale: In 1990-91 it was what you'd call a "V" recovery -- it went down pretty quick but came back pretty fast. This recovery is going to be slower. Everybody has changed the way they look at things. Certain consumer spending patterns were based on home equity and easy money from the banks. That's all going to change.
Crowley: We cannot tell what stage we are in this mess. A lot of things could change, such as the amount of commercial debt that is maturing in the next few years. That could compound the problems. On the plus side, there's the trillions of dollars in government incentives that could start seeping into the system in the next year or so.
Q Can this boom-and-bust cycle be avoided or softened or is it just something the industry has to live with?
Pobuda: I don't think it can be eliminated, but we can continue to learn lessons. We did not forget the lessons from 1990 and 1991. Think about what it would be like now if we had three new office buildings going up in downtown Minneapolis. On the financial structuring of deals in this cycle -- clearly the industry will look back and say we got frothy, with the good luck of being able to sell and re-sell properties for higher values when there really wasn't anything to justify that growth. As the market continued to overheat people were asking if we had moved away from cyclicality and seeing a secular change in commercial real estate. We got our answer, and we got pummeled with it. This was cyclical, very much so.
Susan Feyder • 612-673-1723