Interest Rates are Rising: Relatively Speaking, They’re Still Extraordinarily Low

Five and six years ago, property owners locked in fixed-rate mortgages at rates ranging from 5 percent to 6 percent while thinking that they were getting an incredible deal. In the low interest rate environment we’ve been experiencing, those same investors have been refinancing every mortgage they possibly can to take advantage of the significant cost savings available on debt service. Mortgage brokers have been overwhelmed helping these owners achieve those savings. Again, a great thing for market participants.

The terrible thing about these low rates comes into view when we look at the broader market from a macro perspective. Low interest rates for extended periods of time are indicative of failed economic and fiscal policies. And this period of low rates has been caused by poor policy coming out of Washington. We have pumped trillions into the market, have run unprecedented budget deficits and have a debt to GDP ratio similar to Greece’s (if we take off balance sheet liabilities into account). Long periods of low interest rates also cause asset bubbles.

What the Fed is doing with its seemingly endless quantitative easing policy simply cannot last forever. At some point, not only will the Fed have to stop their easy money policy, but they will actually have to dispose of all the stuff that they have purchased. Realizing that the current policy is unsustainable, Chairman Bernanke sent up a trial balloon a couple of weeks ago to see how the market would react.

His use of the word “tapering” had an immediate impact on markets. The equity markets dropped and interest rates rose. Ben got scared and had a couple of his regional presidents make public statements about how his words were “misinterpreted.” The equity market rose and rates dropped a bit. Expect more of this in the future. The Fed is testing the market. They will keep testing periodically to determine how the market will react. Their hope is that each time they do, the pendulum swings a bit less so they can actually start withdrawing from this unsustainable program.

For the past two weeks, several investors have used rising rates as an excuse to either lower offers or withdraw from deals. There is no doubt that rising rates were not the real reason for these actions.

The facts show that the most observed metric for real estate, the 10-year treasury, has increased from 1.66 percent, on April 30^th, to 2.60 percent, on June 25th, a 94 basis point increase. At the time of this writing, the 10-year was at 2.52 percent, 86 bps above the April 30^th level. However, on average, commercial mortgage rates have increased only 10 to 12 bps, hardly enough to move the needle on any transaction. And on a relative basis, these levels are miniscule.

For some perspective, the long-term average yield on the 10-year is 4.65 percent. On July 23 of 2012, it was an all-time low of 1.41 percent. The opposite end of the spectrum occurred in September of 1981 when the rate was 15.32 percent.

There is no doubt that rates will rise again. The big questions are, When? Why? and How fast? If the economy attains tangible traction, rates will rise and it will be good for everyone. If they rise because of massive money supply increases and easy money, things won’t be so pretty.

But something to keep in mind is that even if rates rise 150 basis points from today’s level, the 10-year will still be less than its long-term average and commercial property borrowers will still be able to borrow at less than 5 percent in most cases. All in all, that’s not such a bad deal and something that the market will gradually adjust to. It will happen, it’s just a question of when and it really shouldn’t be such a travesty.