What Does Quantitative Easing's End Mean for Real Estate Prices?

 

The US Federal Reserve declared this week that its quantitative easing (QE) program of purchasing mortgage-backed securities and US government bonds, which it started in 2008 in an effort to boost the economy by lowering long-term interest rates, would come to an end. propertyfinder

The news did not come as a shock.

The Fed has been signaling this for over a year, in fact taking the Band-Aid off gradually. The market's immediate reaction was measured, with the 10-year U.S. Treasury yield rising just slightly in the previous week—less than 10 basis points (bps) as of midday on October 30, 2014.

The end of quantitative easing is a significant move forward in the recovery from the Great Recession. While the medium-term consequences are difficult to forecast at this time, popular wisdom suggests that interest rates will rise in 2015. Several factors, in our opinion, reduce the risk of a significant increase in interest rates in the medium term.

The most significant factor is the recent weakening of the global economy, especially in the European Union, where a form of quantitative easing was recently introduced and additional stimulus measures appear to be on the way. The slowing of China's economy, which is hurting emerging markets and some developed economies like Germany, is lowering global growth expectations. Other factors include the recent increase in the value of the US dollar, which, combined with lower oil prices, is helping to keep domestic inflation under control.

CBRE, a global real estate consultancy, believes that a significant rate increase is still a long way off, and that the latest announcement would have no effect on commercial real estate.

To back up this argument, CBRE looked back to the events of May-August 2013, when Chairman Bernanke made the first overt suggestion that the Fed would reduce its bond-buying program, sparking the "taper tantrum" that saw the 10-year Treasury yield rise by over 100 basis points in four months.

CBRE looked at actual transactions made by CBRE Capital Markets practitioners following the increase to see how the rise in the 10-year U.S. Treasury affected commercial real estate. The results showed very minor changes in values, with almost no impact in all asset types except multifamily, which was greater than all other asset types despite being small (generally less than 2%). Commercial real estate resisted a sharp increase in long-term interest rates in mid-2013, and CBRE expects it to do so again in the coming years.

According to CBRE, long-term interest rates and real estate cap rates have a good long-term relationship. The lags, on the other hand, are very long, and there are significant medium-term offsets. For example, positive market sentiment has been fueled by high institutional demand for core commercial real estate against relatively limited supply and strong U.S. GDP growth momentum. Most importantly, even in an increasing interest rate setting, pent-up rent rises across the major asset classes—due to rolling leases entered into during the 2008-2010 time frame and new occupancy demand led by a growing economy—should bolster cap rate stability.

Other mitigants include international unrest, which makes U.S. Treasuries, the "risk-free" protection of choice, more appealing and holds prices down, and the increased globalization of commercial real estate funding outlets, where some foreign buyers use financing from their home countries, which have a far lower cost of debt than the United States, to underwrite transactions.

Furthermore, the good news of a tightening labor market cannot be overlooked, especially for many industries that affect commercial real estate directly or indirectly, such as trucking, oil and gas, and construction. Inflation expectations, on the other hand, remain low and steady, and short-term rates are only expected to rise steadily.

"The end of QE speaks to the gathering power of the US economy and will have little effect on commercial real estate prices," said Spencer Levy, head of CBRE Americas Research.