Betting on Interest Rates
How long do we really think interest rates will stay down? It’s probably the most important question facing real estate players today. Low interest rates have allowed many borrowers to sidestep default or foreclosure and enabled refinancing at lower rates than original mortgages. In fact, low rates have allowed the industry to steer mostly clear of the cliff of hundreds of billions of dollars of commercial mortgages refinancing in an environment where many borrowers struggle with balances at or above property values. Simply, they have prevented a debacle.
Of course, the Fed has been artificially keeping rates low at any cost (including killing investment prospects for many savers), because the economy has been so lackluster, and prospects for much improvement over current sluggish levels seem remote.
But can we depend on the Fed to maintain its pledge to keep rates low through 2014 when China and other primary buyers have backed off buying T-bills because returns are so low? As a result the primary market maker for T-bills is the Fed itself. At some point, its print money strategy to buy up its own bonds may hit the skids and it may need to back off the late 2014 marker its set down.
Few observers believe rents and property cash flows will increase enough to keep up with interest rate increases when they occur—rising cap rates would cause some value offsets and borrowers who have not locked in long-term low rates would see debt service increases. This might not be a happy story for investors who recently have been paying top dollar or borrowers sticking to current cheap adjustable rate mortgage schedules. Do you dare to tempt fate? Rates have been down so long that many players have become complacent, and when the complacency barometer borders on blasé that’s when real trouble hits. We’re close to the blasé register right now. It’s time to wake up to the downsides of assuming everything will stay the current course…
Wall Street, meanwhile, talks out of both sides of its mouth… The money folks say they want countries to reduce debt loads and get fiscal houses in order, but stocks spike on any news of stimulus (more debt) and policies to keep interest rates down. Well, of course. It’s more of the same—essentially we all want to do business with other people’s money at as little cost as possible.
It becomes more obvious by the day that the only way out of the debt hole is inflation, and inflation will be good for commercial real estate, especially apartments, hotels, and any properties with shorter term leases where operators can bump terms to keep up. But will inflation kick in while interest rates stay low, a real sweet spot for investors and borrowers? Again, that seems unlikely. Although the Fed historically uses interest rate hikes to tamp down inflation, it may ultimately want to encourage some level of inflation to ameliorate the debt issues. But as noted it may be out of tricks to control interest rate moves going forward. The worst possible scenario is a combination of high rates and high inflation—a back to the early 1980s-style period when savers could get 10% interest on their money market accounts and mortgage rates were double digit too.
Nobody knows exactly where we’re headed on this interest rate/inflation front. But we’re in for some sort of change… sooner than we may think.