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The Evils Of The RTC

How bad government cost hundreds of San Diegans their properties

Recently, I had the pleasure of serving as an expert in the insurance lawsuit of Pershing Park Villas vs. United Pacific & Reliance Life Insurance Cos. What I learned about the lunacy of government interference in the banking industry is disturbing.     In the Pershing Park Villas case, my role as an expert witness for attorneys Clyde Greco and E. Bob Wallach was to educate the jury on how the plaintiffs (who were multi-family mavens) could have earned considerable sums by acquiring foreclosed apartment properties from the Resolution Trust Corp. and other lenders during the 1994-1996 period. The financial gains came through rehabbing the structures and repositioning them in the marketplace to earn higher rents before an eventual sale.     My testimony was accompanied by vivid graphics showing how other local investors reaped enormous gains by following that same strategy between 1994 and 1996. Pershing Park's ability to carry out that formula was thwarted by a personal bankruptcy forced upon them by their insurer's failure to honor their coverage. The jury apparently agreed, awarding the plaintiffs $27 million, reportedly the largest bad faith insurance award in the history of California.     The research done for the assignment also spotlighted the very sad story of how Congress, in passing the Financial Institution Reform and Recovery Act, commonly known as FIRREA, in 1988, ultimately forced some 800 savings and loan associations to close their doors. The root of the destruction was Congress' mandate that the S&Ls triple their capital reserves against active real estate developments. Since few of the S&Ls could marshall those funds, the financial institutions closed in droves.     To address the mess the closings created, Congress formed the Resolution Trust Corp. Paralleling RTC and FIRREA was the onset of the California recession that depressed apartment occupancy rates and rents, thereby driving loans to value beyond the traditional 75 percent to 80 percent level for apartments and other commercial properties. Sales Price Per Unit Conventional and REO Sales Apartment Projects San Diego County Year Conventional Sales Real Estate Owned (REO) Sales REO As A Percentage Of Conventional 1989 $58,279 N/A N/A 1990 $60,776 N/A N/A 1991 $56,228 N/A N/A 1992 $53,463 $35,274 66% 1993 $44,663 $33,157 74% 1994 $40,279 $31,402 78% 1995 $41,320 $32,087 78% Source: John Burnham Co.     Seeing loans rise above the loan to value ratio and not knowing how to sensibly deal with the situation, the RTC started to foreclose on the properties wholesale, driving down already suffering values. Dumping foreclosed projects on an already weak market created a wildly vicious downward maelstrom from which the real estate industry only now is beginning to recover.     (By way of background, some 1,426 apartment properties, from duplex up, changed hands in 1989. By 1992, the total transactions declined to 436, a 70 percent drop indicative of the sick state of the market.)     Foreclosed properties are known in the industry as REOs (real estate owned by a lender). In 1991, in all of San Diego County, there were seven REO properties sold out of 300 sales of projects larger than 20 units. In 1992, that number rose to 45 REO projects, escalating to 139 projects in 1994. By 1994, 47 percent of all apartment projects sold were dealt by the RTC or lenders trying to clean up their portfolio rapidly in order to avoid intervention from the Feds. The black plague had descended; prices crumbled.     At the turn of the decade, the average price of an apartment unit sold in San Diego was $60,776. As the REOs flooded the market, prices of non-REO properties started to decline, plummeting to $40,279 per unit by 1994, a drop of one-third in value. The decline was abetted by the Feds selling REOs for as little as half of the 1990-1991 averages.     Given these massive declines in value, it was only appropriate that a cadre of grave dancers appear on the scene. On the national scene, the name with most fame has been Sam Zell, but we on the local scene had our own group of adventurous entrepreneurs who were bright enough and persistent enough to swoop in and buy wildly undervalued apartment properties en masse.     As part of our Pershing Park research, we were able to pinpoint more than two dozen properties that had been acquired on the cheap through the REO process, fixed up and then resold within a 24-month period. (I emphasize the "fixed up" aspect because the government, during its ownership period, allowed most of these properties to deteriorate significantly.) Most of the complexes acquired and resold within this time frame were less than 50 units in size and were in middle income or poorer areas.     The folks who acquired and disposed of this group of properties saw their properties increase in value by an average of 54 percent; however, as most were acquired with minimal down payments, their return on equity was often in the 200 percent-plus range, and in some cases, much higher.     Those who opted not to sell most often saw their property cash flows increase to legendary proportions, providing them with wonderful income streams and an eventual opportunity to sell their properties at still higher values.     The awful downside: hundreds of local small property owners lost their apartment projects simply because federal lawmakers had managed to severely deflate values. Had Congress not passed FIRREA, there is an exceptionally strong possibility that most of those original owners would still have their properties and we would still have HomeFed and Great American.     In my opinion, FIRREA was the most destructive Federal action in the history of U.S. real estate. It single-handedly killed the S&L industry; cost taxpayers billions of dollars of unnecessary losses; cost local governments untold millions in property tax losses (due to reassessed devalued properties); and caused thousands of small property owners to lose their investments.     Today, many years after the siege, property values are beginning to come back to what they were prior to FIRREA. In the meantime, fortunes were made off the backs of small property owners, including too many in San Diego.     Court is adjourned.     Alan N. Nevin is an economist with Market Profiles, a consultancy providing real estate and demographic statistics, feasibility studies and litigation support to the California land use industry and legal profession. He was director of real estate research for HomeFed from 1989-90.

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