R4 How securitization affected 'traditional' real estate cycle

R4 How securitization affected 'traditional' real estate cycle

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How securitization affected 'traditional' real estate cycle Anthony Downs National Real Estate Investor, Feb 1, 1999 Recent securitization in real estate financial markets has changed the way in which the traditional three-phased real estate cycle will operate in the future. This column explores the nature and effects of those changes. The real estate cycle contains three phases, as often explained in this column. The development boom phase starts at the peak of a general business cycle expansion. But when a lot of properties started in this boom come onto the market, the general economy has gone into a recession, so there is a space surplus on most markets. This causes the overbuilt phase. But ultimately the general economy starts to expand again, and demands for space begin rising. This gradually soaks up existing space, causing vacancies to fall, rents to rise, and property values to rise, although little new construction occurs. This is the gradual absorption phase. Eventually it gives way to a new development boom. The three phases of the real estate cycle * Development boom phase * Overbuilt phase * Gradual absorption phase During 1998, we were in - and in 1999 we are still in - a general development boom in most U.S. commercial property markets. New construction, both build-to-suit and speculative, sprang up everywhere. Demands for space have been growing too, often faster than new supply. But the amount of new supply in the pipeline and planned for 1999 will probably exceed increases in space demand because those increases are slowing down. When 1998 began, we were also in what might be called a "bull market" for existing properties. REITs were bidding aggressively for such properties to expand in size. REITs had been able to raise capital easily because stock prices were rising so strongly, so they could outbid traditional investors. And REITs were under tremendous pressure to grow larger so they could attract large-scale institutional investors who want to deal only with highly liquid stocks - and "normal" liquidity rises along with total size. However, I pointed out then that when the stock market stopped rising so fast, REITs would be unable to float secondary issues and raise capital so easily. Three events proved me right. The first event was that REIT stock prices did not rise along with the rest of the market in the first half of 1998. The second event was that the stock market, itself, took a nosedive in August as a result of a financial panic. This cut off the supply of new capital to REITs almost totally, causing many to back off from aggressive acquisitions.
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