Boom and Bust
A Career, As Viewed Through Three Market Cycles
The Story. Well, Three Stories, Actually
1983-1989: The Spec Office Boom.
After graduating from architecture school in 1985, I worked in firms that designed schools, residences, and R&D lab buildings, offices, and campuses, but some of my friends worked in firms that designed “spec office buildings.” Developing an office building “on spec” means that the developer takes out a construction loan before having secured any tenants, speculating that when the building is done in three years, there will be plenty of potential tenants to fill it and pay the rents required to service the debt and provide a return to the equity investors. Then, in 1989, a lot of architects I knew were suddenly laid off. I was lucky: I was working on a big pharmaceutical project, but other friends who were working on spec office buildings lost their jobs immediately. Several friends worked at a firm just down the street that almost exclusively designed spec office buildings for developers, and they showed up for work one morning to find the doors locked. Their developer clients stopped work on all projects, stopped payment, and many probably had outstanding invoices they had not yet paid. That architecture firm was suddenly out of business.
The spec office boom was driven by the Reagan administration’s efforts to stimulate economic growth following the stagflation of the late 1970s. To spur private investment in real estate, Reagan’s 1981 Tax Act halved depreciation on office buildings, from 31.5 years to 15 years. Straight-line depreciation allows you to subtract a portion of a building’s value as a cost (a paper loss) from your taxable income, which lowers your tax bill. In 1980, the top marginal tax rate for ordinary income was 70% (as compared to 37% today), so reducing the depreciation period to fifteen years meant that you could charge off 1/15th of your real estate investment—a big chunk—every year, and that would lower your tax bill—a lot. This incentivized high-income and wealthy people, such as doctors, dentists, and lawyers, to invest in commercial office projects as “tax shelters.” The problem was that those buildings were largely financed with loans from local and regional Savings and Loan banks, called “S&Ls” or “thrifts.” As demand for investment opportunities grew, those lenders made more and riskier loans, knowing that the federal government insured their depositors’ funds. The practice of taking greater risks because you know that other parties to the contract—US taxpayers, in this case—will pay the price if things go wrong, is known as “moral hazard.” The problem was that the boom in spec office construction was driven not by demand for office space but by demand for tax shelters, and as supply and demand for actual office space became decoupled, developers over-produced office buildings for whom there were no tenants.
“If something cannot go on forever, it will stop.”
- Herbert Stein, President Richard M. Nixon’s Economic Advisor, now known for “Stein’s Law.”
It stopped in 1989 with the “Savings and Loan Crisis” and a “mini-crash,” when one third of the country’s S&L’s failed, followed by a worldwide recession in the early 1990s. In 1989, in response to the S&L bank failures, Congress passed the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), strengthening lending regulations, and at the same time created the Resolution Trust Corporation (RTC) as a vehicle to acquire and then dispose of those banks’ assets, which the government, as guarantor, now owned. In the depths of the recession, savvy developers who weren’t wiped out and had kept some dry powder were able to swoop in and purchase these properties for pennies on the dollar, setting the stage for future development cycles. According to a 1989 market study by Solomon Brothers, the decoupling of demand and supply during the 1980s meant that by 1990 there would be enough new office buildings completed or in production to supply future office needs in the United States for twenty years—until 2010—without anyone needing to build a thing.
2001-2008: The For-Sale Housing Boom.
In 2004, after moving to Minneapolis, I decided to get a job in development. I worked on a few townhome and condo projects, and then I landed a huge opportunity, managing the development of a 33-story condo tower. We had our first meetings with city officials and the community in August of 2005, and spent the next two years working with the community, designing the building, seeking approvals, lining up financing, building our sales center, and launching our marketing and sales effort in early September 2007. We planned to create a lot of hype and make sure that on opening day, the sales center would be swarmed with potential buyers, creating a sense of urgency, scarcity, and demand, leading to the sellout of all 330 units in just a week or two. Then, just a month before our launch, a French bank called BNP Paribas froze its funds because of illiquidity in the US subprime mortgage market—a flashing yellow light on the dashboard that I, and most other people, did not fully understand at the time.
We kicked off sales with a “friends and family” party on a Friday night, and the next day was the big, heavily publicized, public grand opening. We had enlisted a platoon of sales agents to take reservations from the thronging horde of condo buyers, but on that unseasonably warm Saturday morning, when we expected people to be lined up around the block, there was a line, but it did not extend around the block. The developers I worked for were so freaked out that when the mayor came by that morning and was waiting outside, wondering where everyone was, I couldn’t get them to come out of the office, leaving me to make small talk with him on the sidewalk. I’ll never forget the cold feeling of dread I had that day, and the gallows humor from our team when we went out for drinks that night. I was relatively new to the business and knew it was bad, but the developers I worked for must have known, deep down, that we were dead. In that first week, we signed reservations for 110 of the 330 units, and then it was a treadmill from there on out, for weeks and then months, as we would sign one more reservation only to have someone else call us and say they had changed their mind and could we please return their $2,000 check. Back then, you needed to have reservations for at least 50% of your units before a bank would make a construction loan, and we never got past 30%. The press had been screaming for months about the economy, interest rates, inflation, overbuilding in the BRIC countries, and a housing bubble in the US, and people had become more cautious and even fearful. We were late to the market, and we never built that tower, although we did spend several million dollars to get to that warm fall day when we opened our sales center.
Savings and Loan banks originated home mortgages in their communities through the 1960s, but lending across the US was uneven because it was based on local conditions and how well capitalized individual local S&Ls were. The 1970 invention of the mortgage-backed security, or MBS, changed all of that. This is how it worked: S&Ls and local banks originated mortgages and then sold them to bigger banks, who sold them to Wall Street, who pooled them into MBS, creating a security that could be sold to investors, and which was backed by pools of mortgages and the payments of homeowners. The benefit of the mortgage-backed security was that it liquified capital and made it easier for people to get home mortgages everywhere, since investors removed the risk from the local banks. The downside was that, since their depositors’ funds were insured by the federal government, those local banks were incentivized to take greater risks and issue more loans. As in the spec office boom and S&L crisis, moral hazard, once again, created perverse incentives for the banks.
“Once a lender sold a mortgage, it no longer had a stake in whether the borrower could make his or her payments.”
- All the Devils Are Here, MacLean and Nocera, p. 19.
Banks make fees on every loan they originate, so, as the economy heated up and development accelerated, banks lowered their underwriting standards and originated more “sub-prime” loans—loans to people with questionable credit, or so-called “no income, no job” or “NINJA” loans. At the same time, they made more high-leverage loans to real estate developers to build new single-family, townhome, and condo communities. In addition to the banks, The Federal government, through Fannie Mae and Freddie Mac, also entered the market in a big way, guaranteeing more loans with the admirable goal of making homeownership in the US accessible to more people. Since investors from within the US and around the world all wanted to invest in American real estate, Wall Street was incentivized to buy more mortgages and package up and sell more MBS, while banks were incentivized to issue more mortgages and more loans to developers that they could sell on to Wall Street. “Perverse incentives”—earning more fees from loans through poor underwriting and moral hazard—combined with what real estate economist Anthony Downs called a “Niagara of Capital” pouring into American real estate during the 2000s, led to a decoupling between the growing demand for investment securities and the actual demand for homes. This caused homeowners to buy more home than they could afford, hoping to flip, and developers to overproduce housing. Zombie projects got built for which there were no real buyers, investors bought and flipped houses, and everyone became a realtor. It ended in the Great Financial Crisis, when 465 banks failed or were acquired by bigger banks, and about 700 remaining banks received government bailouts through the Troubled Asset Relief Program (TARP), with US taxpayers footing the bill. And like the creation of FIRREA in 1989, it also led to the passage of the Dodd-Frank Act and the creation of the Consumer Financial Protection Bureau (CFPB), all with the purpose of reigning in banks and their lending practices and preventing another Great Financial Crisis in the future.
Let me end this boom story with an exchange from Michael Lewis’s non-fiction book and movie, The Big Short:
Mark Baum: Okay, look. If home prices don’t go up, you are not going to be able to refinance. And you’ll be stuck paying whatever your monthly payment is once it jumps up after your teaser rate expires. Your monthlies could go up two-, three-hundred percent.
Florida Strip Club Dancer: James says I can always refinance.
Mark Baum: Well, he’s a liar. Actually, in this particular case, James probably is wrong.
Florida Strip Club Dancer: 200 percent? On all my loans?
Mark Baum: What do you mean “all” your loans? We’re talking about two loans on one house, right?
Florida Strip Club Dancer: I have five houses... and a condo.
The housing boom was based on one big, simple assumption: That housing values in the US never go down, they only go up, so you can’t lose by investing in American homes, which was true, until it wasn’t. Sound familiar? All of this laid the groundwork for the current rental housing boom.
2008-Present – The Rental Housing Boom and our “K-shaped economy.”
In January 2008, while my condo tower project was languishing, I started teaching a course to graduate students in city planning called “private sector development,” although the topic had become academic, because in the real world, development had stopped. But it was the September 2008 collapse of Lehman Brothers, an investment bank, that really started the Great Financial Crisis. The next several years were characterized by government interventions, bank mergers and acquisitions, stalled development projects, home foreclosures and short sales, and the end of home mortgage lending for the next couple of years. But while many people were wiped out, those people who showed more caution were left with cash…and a unique opportunity, starting with single-family rental homes.
There is an old saying in real estate: “You make your money when you buy.” The idea is that if you buy a piece of real estate at the right (low) price, you are better prepared to weather ups and downs. If, on the other hand, you buy high, the only way is down, and you have less margin for error when conditions change. Sometimes you’ll hear a developer say, “I bought it right.” Well, after the Great Financial Crisis came the Foreclosure Crisis. This was the time to “buy it right.” While there was still the economic drive to create more housing, the capital available for single-family home mortgage lending had dried up. So developers, investors, and lenders pivoted to new rental residential real estate products, beginning with single-family rental (SFR, typically for low- to moderate-income tenants), and when the market started coming back, market-rate luxury apartments, build-to-rent communities, and short-term rentals (STR) or vacation rental properties.
Single Family Rental (SFR): In low-income neighborhoods around the country, homeowners who refinanced during the housing boom at high valuations with adjustable-rate mortgages (ARMs) saw their low “teaser rates” expire, and their mortgage payments jump to amounts they could not afford to pay, while holding homes that were worth less than their loans. Some struggling homeowners sold their homes in short sales, and others lost them to foreclosure, so a lot of low-cost houses flooded the market. This is when the private equity firms came in to “buy it right” – rapidly acquiring houses one at a time—often with cash—creating large portfolios of distressed single-family homes at a huge discount. Investors in Private Equity funds typically seek to earn a significant return in seven years—a short time frame for a real estate investment—and this led to a business model that relied upon efficiencies of scale, distant ownership, cost cutting, reduced service quality, deferred maintenance, hiked rents, and evictions to generate the needed returns to investors.
SFR was the downward-pointing leg of the K-shaped economy, emphasizing how the rich are getting richer and the poor are getting poorer. The upward-pointing leg of the K-shaped economy graph—the rich getting richer—led to the production of other rental housing product types and investment opportunities.
Multi-Family Housing (MFH): Starting in 2009, as the lending market began to recover, developers started producing luxury apartments. The housing and condo boom of the 2000s had made cities attractive places to live again, so the first projects were located in transit-oriented, amenity-rich, urban locations. Later projects, reflecting inclusive zoning ordinances, included affordable units, and private developers and nonprofits produced some fully affordable projects using low-income housing tax credits (LIHTC). New, market-rate luxury apartments in the suburbs followed.
Build-to-Rent (BTR) communities: Another product type to emerge from the GFC was the Build to Rent (BTR) community (BTR)—centrally owned and managed suburban subdivisions of rental homes marketed to millennials forming households who can’t afford to buy in the best school districts, and to wealthy boomer retirees and seasonal residents.
Short-term rental (STR) properties and communities: Last but not least, services such as Airbnb and VRBO drove a boom in the production of vacation rental home communities, although many municipalities began to regulate the number of vacation rentals in the early 2000s. STRs offer the best demonstration of the K-shaped economy and the mismatch of housing supply and demand, because while the housing shortage in the US has only grown, many of these properties and communities remain vacant as much as 60% of the time, yet their high rents still make them lucrative investments.
The current boom started in the 2010s, when investors with wealth swooped in to pick up the pieces from the Great Financial Crisis, buy bank-owned/foreclosed houses at a huge discount, and create single-family rental portfolios. Private equity, REITs, Sovereign Wealth Funds (Commoditization of equity, similar to MBS last time);
Similar to the previous two booms, the rental housing boom has been driven by demand for profitable investment opportunities in real estate. And similar to the previous two booms, this cycle was driven by excess capital, but with an emphasis on wealth disparities, the K-shaped economy, a growing housing shortage, and need. This boom was different than the previous two in one way: Because the US government does not guarantee the funds invested in real estate investment trusts (REITs), private equity funds, and sovereign wealth funds, there were fewer perverse incentives and less “moral hazard” this time, and therefore more caution, perhaps because the GFC is a not-so-distant memory. And that may be why we haven’t seen the bursting of this real estate market bubble, even as things have cooled off since 2025.
The Lesson
All boom-bust cycles start the same way, with good intentions and a solution to a real problem or a response to a fundamental need. But then there is a shift, from investing to fill that fundamental need to investing to invest. Booms are not driven by demand for space, but rather by excess capital seeking returns, in combination with perverse incentives and moral hazard, and they end with a decoupling of product demand and investment demand. In the 1980s, the Reagan administration was trying to shock the US economy out of the stagflation of the late 1970s by creating incentives for people with wealth to invest in real estate. This led to the spec office boom, fueled by the wealthy’s overinvestment in tax shelters, causing the oversupply of office buildings, a mismatch of supply and demand, and the failure of the banks that made the loans for those projects. The Housing boom of the 2000s was fueled by mortgage-backed securities—commoditized equity—which enabled overinvestment in the appreciation of residential real estate by Americans as well as foreigners. The Boom of the 2010s was fueled by REITs, private equity, and sovereign wealth funds from other countries—a different type of commoditized equity, at least without government backing this time. So far, despite the rental housing boom, a real estate bubble and bust does not appear to be on the horizon, so maybe we have all learned—at least a little—from the previous two cycles.
History doesn’t repeat itself, but it often rhymes
- Mark Twain
My thanks to my colleague and friend, Murray Kornberg, for reviewing and commenting on multiple drafts of this essay. Any errors are mine alone.