Interest rates were at very high levels, and mortgages were not economically viable. In fact, most mortgages were being written with a negative spread, making interest rates higher than the yields from the real estate. Real estate was being bought with negative cash flow. Real estate projects unable to meet debt service were being refinanced with mortgages with negative amortization, whereby the principle increases even though the monthly payments are being made.

Considering those conditions, what was the driving force behind commercial real estate values? In 1981, new tax legislation, the accelerated cost recovery system (ACRS), was passed. This new tax law defined and liberalized the length of depreciation schedules. Prior schedules used by owners were considerably longer then the ones proposed by ACRS. Thus larger deductions against ordinary income became available, resulting in less paid in taxes and a higher yield from investing. This created a new cottage industry of lawyers, accountants, promoters, etc., who were dedicated to finding more and larger tax deductions. With tax rates of 50% and higher, many investors received tax benefits that created yields in excess of their investment during the first year. The higher the price for the real estate and the greater the leverage, the higher the tax deductions. The yields created from the tax benefits drove commercial real estate values farther away from their operating yield while construction activity drove operating yields lower. Tax benefits were the driving force behind commercial real estate values for the 1981-85 period.

The driving force behind commercial real estate prices: 1986-1990

In October 1986, the Tax Reform Act was passed and thus ended tax deductions against ordinary income – the cottage industry of tax experts, developers, and inflated real estate values that were driven by tax benefits. Consequently, many owners were left with vacant real estate, too much debt service, negative cash flow, balloon payments, and increasing environmental costs, leaving them with two options: refinance with lower debt service or go into foreclosure. Although this was a period of weak real estate prices, lower debt service and low construction activity started to stabilize yields. Real estate prices that stabilized or increased during this period did so because of lower debt service. Refinancing was the driving force behind commercial real estate prices during this era.

The driving behind commercial real estate values: 1991-1994

The 1991-1994 commercial real estate era witnessed a mixed bag. Construction continued to remain at low levels, bringing about a better supply/demand relationship. The benefits of less construction were somewhat offset by corporate downsizing. Excessive debt added during the 1980s started the downsizing activity, and then it became a staple of management technique.

Real estate was affected by a new factor during this period: technology. Technology contributed toward further reduction of employment. Everyone was affected, including blue-collar, white-collar, and management personnel. The result was less need for office space. Layoffs lowered consumer confidence and subsequently changed consumer buying habits, all of which, of course, affected retail real estate. These same factors lowered the demand for residential space, and although the supply/demand relationship had improved, there were still excesses in the three core types of commercial real estate: residential, office and retail.

What drove real estate prices during this period? Stabilized and improved real estate increased its operating yield and interest rates declined, making commercial real estate a very competitive investment. But the bad taste of the late 1980s value declines and the lack of liquidity frustrated investors from buying commercial real estate.

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