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SPEAKING OUT

Southland Real Estate: Did We Learn Our Lesson?

October 21, 1990|JACK RODMAN | Rodman is managing partner with the Los Angeles office of Kenneth Leventhal & Co.

The paralysis in Southern California real estate markets reminds me of a classic scene in Laurel and Hardy movies. After each new mishap, Ollie looks helplessly at Stanley, throws his hands in the air and says, "Well, this is another fine mess you've gotten me into."

That same conversation might just as easily be had today by a real estate lender meeting with a hapless developer who once again finds himself struggling to stay afloat in falling markets.

The malaise hanging over the real estate industry nationally has touched even Southern California, once considered impermeable to recessions plaguing other parts of the country. While our population continues to grow rapidly in the Southland, new home building and other urgently needed development have come to a virtual standstill.

We face parallel dilemmas.

After years of banking industry deregulation, the pendulum has swung again to the opposite extreme. Federal regulators have levied rules of such strictness on banks and thrift institutions that capital for new development is virtually unavailable. Real estate lending is the financial community's "bad boy."

At the same time, we face a paralysis in regional leadership required to confront the reality of growing populations and declining public services in Southern California.

The LA 2000 Committee put forth an ambitious vision for the Los Angeles metropolitan area as a world finance and cultural center--a model city of the future.

Is that vision now threatened by our inability to provide for the growth needed to support economic health? Does Southern California face the same fate as New York, Texas or Arizona, where collapsing real estate markets were harbingers of wider economic problems?

I don't think so. But to avoid repeating the past, we must understand how we arrived at our present difficulties. The roots can be easily traced. In fact, we are today paying penance for the sins of the last decade.

The genesis of our problems springs from events in the late 1970s, years of "stagflation." Economic growth was flat, interest rates were high and inflation was running out of control.

As that decade ended, the government took two fateful steps intended to stimulate the economy. Congress passed the Economic Recovery Tax Act of 1981--a law which ushered in a flood of tax-sheltered real estate investments. Investors reaped 4-to-1 tax writeoffs. Real estate projects were financed regardless of whether they made economic sense.

At the same time, deregulation of financial institutions opened up vast new sources of funding for speculative real estate projects.

Savings and loans suddenly were able to form subsidiaries owning a smorgasbord of assets ranging from fast-food chains to real estate companies.

The world looked rosy for real estate in Southern California. The Reagan Administration's kitchen cabinet had cooked up a host of initiatives intended to correct the legacy of the previous administration.

In the pendulum's swing back, however, the most severe overbuilding in the country's history took place. Syndications and limited partnerships went wild with tax-sheltered investment funds pouring into the marketplace. Wall Street was booming, and limited partnerships raised billions for new development.

The initial ripple of concern came with the collapse of oil prices in the early 1980s. The first savings and loans to go under were located in the country's Energy Belt, auguring the financial hemorrhage of the thrift industry that would take place by the end of the decade.

In 1986, excessive abuses in tax shelters led to a new tax act, legislation dedicated to simplifying the tax code--a 954-page document that still defies complete understanding.

Tax shelters for real estate investment were eliminated. Syndications and limited partnerships died almost overnight. Declines in real estate in the Energy Belt spread to the Northeast by 1987.

And the multibillion-dollar bailout of the thrift industry was in full swing by the end of the decade.

Clearly, the sins of the past need correction. But we have now entered a period of over-regulation that may be offering a cure just as destructive as the illness.

Twin forces have forced financial institutions to curb real estate lending: shareholders and regulators.

Wall Street and other investment analysts who value bank stocks have generally concluded that real estate debt is an albatross around the neck of institutions. Banks have put as much distance between themselves and real estate lending as possible.

In addition, strict new capital requirements under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) are forcing banks to limit real estate lending. Banks are fearful of triggering regulatory review with respect to outstanding real estate loans.

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