reform (Follain, Hendershott, and Ling, Real estate markets in the early 1990s1987). In the first part, we developed a differ markedly from the 1980 market intheory of tax law changes that inter- at least two important respects. First, al-preted the lengthened tax depreciation though 1990 real interest rates are aboutschedules and increased capital gains tax equal to 1980 values, the combination ofrate as a rational response to a decrease cuts in regular income tax rates and equalin the inflation rate. In the second part, reductions in both nominal interest ratesweforecast the long-run impact of the 1986 and expected inflation has doubled realtax act on real estate, assuming no future after-tax interest rates. As a result, 1990tax changes. In an exercise in account- investment hurdles rates or user costs forability, we now evaluate the accuracy of all real estate (and non-real estate) in-our theory and forecasts. vestments are substantially higher. Sec-The theory and its implied forecast can ond, a lending frenzy has produced a glutbe summarized briefly. Under U.S. tax law, of commercial real estate in most regionstax depreciation allowances are based on of the country, and a substantial excess ofhistoric cost and nominal capital gains are multifamily residential units in some re-taxed. Arguably, allowances and gains gions. Moreover, this glut (excess) wasshould be indexed for inflation (deprecia- produced during the 1983-86 period andfion should be based on replacement cost thus has already existed for over five years.and only real gains should be taxed). In Two of our 1987 forecasts appear off thethe absence of formal indexation, depre- mark, one by a wide margin. We pre-ciation allowances should be shortened and dicted small increases in real rents andcapital gains tax rates cut when inflation decreases in real values for income-pro-rises, and historically this has been the ducing real estate. For apartments, realcase. Thus we forecast that a significant rents have been flat and real values havecut in the capital gains tax rate and declined, although the evidence is mixedshortening of tax depreciation schedules and varies by region. For commercialwould come only if inflation accelerated.' properties, both real rents and real valuesInflation has not accelerated, and the cut have plunged. The poorer-than-expectedand shortening have not occurred. value performances are obviously causedForecasting is a dangerous business as by the lower-than-expected rental incomethe cardinal rule for forecasters suggests: streams.3 Below expected rental income isgive them a number or give them a date, attributable, we contend, to the over-but never give them both. While we gave building in the middle 1980s, not to aseveral numerical long-run forecasts five misunderstanding of the 1986 tax provi-years ago, we contend that five years isn't sions or their ceteris paribus impacts.the long-run and for some real estate While one might think that ample timenwkets we should not yet expect to see has passed for us to be seeing the long-any of the forecasted impacts. Tax law run economic impacts of the 1986 tax act,changes are just one of many possible dis-and that may be true for impacts in sometwi)ances to real estate markets, and onlyin the absence of other major distur- markets, it is decidedly not true for in-come-producing real estate. Overbuildingin the middle 1980s has simply swamped'Syracuse University, Syracuse, NY 13244-1090. the long-run effects of the 1986 tax act.*wMeOhio State University, Columbus, OH 43210. Regarding owner-occupied housing, the