Understanding the ebbs and flows of the real estate market is crucial for making informed investment decisions. These pivotal historical shifts—such as the Tax Reform Act of 1986 and the Savings and Loan Crisis—are important for extracting actionable insights for today's market.
Tax Reforms: The Catalyst for Change
In the mid-1980s, the U.S. real estate landscape was transformed by the Tax Reform Act of 1986, which drastically altered investment incentives. The lucrative tax shelters that had drawn so many to property investment—like accelerated depreciation and deductions for passive activity losses—were effectively dismantled. Properties were no longer as appealing without these tax benefits, leading to a sharp decline in values. This pivot was more than a market correction; it was a fundamental shift, setting off a chain reaction across the real estate sector.
As property values tumbled, the savings and loan institutions (S&Ls), which lent heavily into real estate, found themselves on precarious ground. Borrowers were unable to pay back their loans, and the S&Ls found themselves at the brink of collapse. The crisis led to the failure of about a third of the 3,234 savings and loan associations in the United States between 1986 and 1995. To stabilize the banking system and stem the tide of failures the federal government stepped in.Enter the Resolution Trust Corporation
In came the establishment of the Resolution Trust Corporation (RTC) in 1989. Tasked with liquidating assets from collapsed S&Ls, the RTC flooded the market with properties sold at significant discounts. This was not merely a sale; it was a market reset button, providing a unique opening for those with capital to seize on these distressed assets.
This era saw the emergence and ascension of several now-legendary figures in the real estate investment world:
An intriguing aspect of today's real estate market is the extent of the valuation correction in the office sector, which, in some cases, has surpassed the downturn observed during the RTC years. After decades of escalating property values, fueled by economic growth, low-cost, and robust demand for office space, the pandemic has accelerated a transformative reassessment of office real estate.
Today, we are seeing property values in some markets drop to levels that are, in real terms, even lower than those during the late 1980s and early 1990s. This decline is more pronounced given the prior market highs, which were driven by high demand and speculative investment, much like the pre-RTC boom. The correction brings not only challenges but also substantial opportunities. Prices that undercut even the RTC-era lows create entry points for new investors and possibilities for existing investors to expand portfolios or reposition assets to align with the evolving demands of the post-pandemic world.
For example, below is a non-inflation adjusted view of prices in San Francisco. In nominal dollars, San Francisco office is at similar levels as it was in the mid-1990’s, yet replacement cost is 3-4X higher as it was during the 1990’s. This just may be RTC II…but without widescale government intervention, as banking institutions are better capitalized than they were 30 years ago.
It is imperative for investors to understand that not all opportunities in today's market will yield returns equally. The landscape has changed dramatically, and strategic discernment is crucial. The sectors that will rebound may differ from those that thrived pre-pandemic, and some properties may never return to their former valuations. Investors need to be selective, focusing on locations and property types that align with emerging trends, or how people are utilizing space. We saw the same for other sectors, such as the rise of e-commerce influencing demand for warehouse spaces over traditional retail locations, or the increasing importance of amenities in residential buildings. Perhaps the biggest opportunities will be in office but being selective in those will be extremely important.
As we observe the current downturn, the lessons from the past are more relevant than ever. The transformative impact of the 1986 tax reform parallels today's shifts, driven by a pandemic that has reshaped how and where we work. Both eras highlight the potential for strategic acquisitions during market lows. While the RTC era featured direct government intervention in asset liquidation, today's market requires a more nuanced approach, adapting to the evolving economic landscape and leveraging opportunities presented by historically low valuations; an opportunity we might not see for another 30 years.
