A market out of balance.

It is truly amazing how quickly and significantly the real estate business has come roaring back to life. Once again the investment community has recognized the opportunities, diversification and yields this business has to offer.

As the industry emerges from a recession-induced hiatus, activity has become brisk and prices have moved up rapidly, although nowhere near the level of the 1980s. The feeling among many is that the bottom in most sectors has been reached and the excess capacity of the 80s has been absorbed. We are experiencing a barrage of activity and a market flooded with new equity and debt capital from insurance companies, pension funds, REITs and foreign groups all in search of good deals.

Investors, both institutional and private, together with lenders are returning to the marketplace with a vengeance. With so much money chasing so little product the direct effect will be on cap rates, which are moving lower. All indications are that upward pressure is building on prices, rents and development. For the real estate industry, this usually signals the reversal of a down cycle.

Hot items leading the way among investors and lenders are apartments, anchored retail, regional malls, power and big box centers. Hotels are also back in favor once again, as people realize they are doing quite well. Some excellent assets can still be found at below replacement costs, particularly in the Downtown office sector, which has been slower to rebound than other categories.

The good news for owners is in Property Market Performance, where improving fundamentals are leading the way to higher prices and better returns on both debt and equity investments. Also, the market should not face anymore increases in interest rates at least for the short term. We will be looking at a much more stable environment throughout the balance of 1995. Lenders are going to great lengths to make attractive deals work for borrowers. Although they have been careful to stay within prudent underwriting standards, rates are relatively low and the cost of capital has dropped sharply. Spreads continue to shrink while loan-to-value (LTV) ratios and amortization terms moved somewhat in favor of the borrower. On highly attractive deals, fees and closing costs have been altered.

Pension funds will increase their equity real estate investments. At $4.8 trillion today, they will look to double in size over the next 10 years. This means these funds will have to invest more than $250 billion of new capital in the form of equity and debt, just to maintain their current allocations. Consequently with all this institutional and private capital earmarked for real estate, investment activity will accelerate dramatically in virtually every property type and size.

Now for some bad news, which should be obvious. It is your basic supply and demand "Economics 101." Demand exceeds and outweighs supply. The market is out of balance, with more money chasing owners than owners chasing money. However there is a difference between today's buyers and those of the 80s. They are better capitalized and are less likely to compete aggressively for a property as they once did. If the pricing is not right, it is very hard to move the product. But when value is offered, sales are completed very quickly.

In today's market, real estate is sold with more frequency on an all cash basis, with lending institutionsplacing new debt. Key to today's investor's equation are present and future appreciation of value and price growth.

The development of commercial mortgage back securities (CMBS) through Conduits were formed to enable the real estate industry to tap large sums from the general capital markets by packaging loans into securities and selling them to the public. Unfortunately they have failed to originate the anticipated volume. Most have fallen victim to an interest rate climate that is less favorable, together with aggressive competition from traditional lenders such as banks, pension funds and insurance companies, who are actually in the market. Conduits will not disappear though, as there is a definite place and need for this type of financing and the product they offer to the Class B & C asset market.

Real Estate Investment Trusts (REIT's) are looking good after years in the investment doghouse. They have undergone an amazing growth from just five funds in the 90s with $80 million in assets to 22 funds last year with $1.5 billion.

In our perfect world of real estate we shall have satisfied clients, tenants, lenders, borrowers and investors. We shall see Congress and the policy-makers lower the capital gains tax, modify depreciation rules, allow environmental remediation cost to be deductible, repeal the Cuomo tax, commercial occupancy tax, and rent control. All of which would go a long way to creating jobs and correcting the imbalance of the market by unlocking owners who have held property for long periods of time and are just waiting for the right opportunity to cash out.

Oh well, so much for balance in a perfect real estate world.