Those Who Fail to Study History are Doomed to Repeat It – Winston Churchill

As a young commercial real estate lender in the early 1990s searching for new business, I would call on existing clients and prospects and ask what their plans were for the upcoming year. The overwhelming response was “stay alive until ‘95” – a sign that choppy waters were ahead and would be for several years. I believe the legendary developer Sam Zell is credited with coining this phrase.

Late last year, I was speaking with a former colleague at Ernst & Young’s Kenneth Leventhal Real Estate Consulting Group. I asked him what he was hearing from his clients about the prospects for the real estate market. He said many were saying “Begin again in 2010”. I am not sure if Sam Zell coined that phrase as well.

I believe the worst for commercial real estate is still yet to come.

In 2005, British author, Fred Harrison published Boom Bust, warning that the property markets worldwide were subject to a sharp downturn at the end of a regular 18-year cycle. His prediction was based on a study of property markets over the last 200 years.

He wrote that since 1955 to the present, property cycles have occurred every 18 years: 1955 to 1973-4, 1973-4 to 1991-2, and 1991-2 to 2010.

The boom part of the cycle lasts 14 years and is followed by a 4-year decline.

History proves his theory. For example, real estate prices rose from their low of 1955 to their peak in 1969, and then declined for 4 years. In 1973, real estate values were at a low. They rose for the next 14 years peaking in 1988, and slumped 4 years later to another low in 1992. Prices began to rise in 1992 and continued their rise until they peaked in 2008.

If history holds true, we will not see the bottom in property prices until 2012.

The greatest speculation in real estate always occurs in the final years of the boom — a time when trading in real estate and land becomes frenetic and the dominant psychology is that properties must be purchased at all cost. Harrison calls this time frame ‘The Winner’s Curse’.

This occurred most recently in 2005, 2006, 2007. Unfortunately these rosier times remain fresh in the minds of property owners looking to sell, brokers representing them, and bankers seeking to unload non-performing loans.

The reality of the situation is that during the typical four year period of decline following a boom, prices (on average) fall 30% for commercial property (50% for raw land). Equally important to note is that those investors who purchased property during the frothy times have negative equity in their properties and will for years to come. And those highly-leveraged investors will likely not survive the downturn.

Bad debts must be paid off or wiped out – the wreckage must be cleared before the economy can move on.


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