A "revolution" in the financial climate for housing during the past five years has drawn capital away from mortgage lending, and housing is unlikely to recover its once-favored position in the capital markets in the near future, according to a new study by the Brookings Institution.
The study, "The Revolution in Real Estate Finance," by Brookings fellow Anthony Downs, says the changes are primarily the result of federal policies dictated through the tax code and other support systems that now favor nonresidential real estate investments. Without major changes in those policies, the study asserts, housing will continue to lose its share of capital into the 1990s.
The study also challenges the now-popular notion that housing is less affordable today than during the late 1970s. According to the report, if people had been willing to save moderately for the last six years, they would be just as able to afford housing today as they were in 1979.
"There has been a series of dramatic changes in the environment of real estate finance, and because real estate is the most widely dispursed and largest form of wealth in the United States, . . . this revolution affects a tremendous number of people," Downs said in a press conference this week. "This revolution, I believe, and its impacts are going to be with us into throughout the rest of the '80s and perhaps into the '90s."
According to Downs, the major changes have occurred since the mid-1970s. They include:
*Uncertainty among financial institutions about future inflation.
*Federal fiscal and monetary policies that have reduced inflation and raised interest rates.
*Partial deregulation of financial markets.
*Advances in the ability to transfer funds electronically that have speeded up the reaction times of investors around the world.
As a result, office rather than housing development is now the preferred real estate investment, and other forms of real estate -- such as rental buildings, industrial space and retail centers -- are likely to be the preferred real estate investments of the future.
This strong bias in U.S. capital markets towards nonresidential real estate has led to what Downs calls "chronic rather than cyclical" overbuilding of office space.
Downs also says that deregulation and federal support of savings and loans associations and other real estate-oriented financial institutions has changed the way risks relate to rewards among managers of those institutions. That, in turn, has led to turmoil inside those institutions and the potential for failure of the savings and loan industry.
"As long as we have a basic economic strategy of big deficits . . . with high interest rates, we are going to have a situation that is relatively adverse to housing and which causes a relatively high flow of funds into nonresidential property," Downs said.
According to his analysis, federal tax benefits and federal deposit insurance has made it cheaper to raise money for real estate than for other investment. Consequently, large institutional investors such as insurance companies and pension funds are finding commercial real estate a far more attractive investment than housing, even if the market for such commercial buildings is saturated.
While some large investors are beginning to hold back on office-space development, Downs said that most large institutions still are willing to make loans for construction projects in cities with major office gluts.
"If a lending institution has money, it will lend it," said Downs. "If it can't find good loans, it will make bad loans. If it can't make bad loans, it will make terrible loans, and if it can't make terrible loans, it will make horrible loans."
Downs cited as an example a recent loan made by one of the largest financial institutions in the country, a bank, for construction of a 1 million-square-foot building in downtown Houston despite a whopping office vacancy rate of 24 percent.
Downs said that, when the lending officer was asked why he approved such an irrational loan, he responded by saying that the only alternative was lending the money to Argentina.
"Banks are desperately looking for places to put their money, and this has brought them into the overexpanding mode along with the savings and loans," Downs said. He said that, even if office building stopped completely today, there would still be enough space available for new and expanding businesses for the next three to four years.
"If developers can finance out -- that is, get equity or loan funding that will pay the cost of their project -- they will fill the world with empty buildings," Downs said. "They don't care if there are any tenants."
"The purpose of deregulation was to allow the S&Ls to diversify, to get out of the business of borrowing short and lending long which is what home loans entail during periods of volatile interest rates, but, unfortunately, there is nothing big enough to absorb their size," Downs said in explaining why the savings and loans still are concentrated in real estate investments. "There is $1 trillion in savings and loan assets. Where could $1 trillion go? There isn't anyplace for it to go. Real estate is still the biggest investment in the economy."
Downs also said that the S&L industry, which was hurt severely by the inflated interest rates of the late 1970s, still is "teetering on the brink." If interest rates rise again soon, he added, the industry and the Federal Savings and Loan Insurance Corp. could face serious problems.
"FSLIC has assets right now of about $6 billion, and it would take $3 billion to bail out just the two worst savings and loans," Downs said. "And there are over 300 savings and loans in some kind of trouble or difficulty."