Participants in the commercial real estate industry are caught between wanting the economy to tangibly recover and wanting it to continue its slow slogging recovery.
While a tangible recovery would be very helpful for underlying fundamentals, it would cause interest rates to rise. It’s easy to connect the dots between our extraordinarily low interest rate environment and the tremendous recovery seen in commercial property values. On the flip side, while a recovery similar to the proverbial “pushing on a string” doesn’t do much for the economy, it does keep interest rates low, further encouraging market participants to, well, participate.
I know you are probably saying, “Interest rates again? Come on, Knakal, come up with a new topic.” The fact is that the extent to which rates rise and how quickly they accelerate will have a more profound impact on our capital markets than any other metric, so, yes, it is tremendously important to focus on what happens with rates. The volume of activity in the building sales market and our mortgage markets is highly correlated to the interest rate environment.
Last Friday, the Department of Labor announced that 195,000 jobs were added in June. Normally, I wouldn’t put too much stock in the April, May and June numbers, because the birth/death rate model that DOL uses makes the assumption that a lot of new jobs are created by new companies that are formed during these months, which it has no way of proving. However, DOL revised its April and May figures by a total of 70,000 more jobs than it had announced. This would appear to be a positive sign for the job market and the economy. At least this is how the marketplace is interpreting the way the Fed will interpret this data.
The market reacted quickly to this news. Within eight minutes of the report being made public, the yield on the 10-year Treasury (a key metric for commercial real estate) rose by 10 basis points, and later in the trading session it reached 2.718 percent, the highest it has been since August of 2011. Rates on 30-year residential home mortgages, which were below 3.5 percent in April, rose to 4.29 percent last Friday. Fortunately, commercial mortgage rates did not react the same way and will probably remain at modest levels for now, given their relatively short-term nature.
If we peel away the layers of the report, however, things don’t look quite so rosy. While almost 200,000 jobs were created, the unemployment rate remained at 7.6 percent. This was due to more folks coming back into the labor market, which drove the participation rate up slightly from 63.3 percent to 63.4 percent, offsetting the job gains. And looking closely at this year’s figures shows that just 19 percent of all jobs added were full-time positions. The balance were part-time positions or positions with temp agencies.
So today in the U.S., we have about 12 million Americans who are “officially” unemployed. They are joined by eight million people working part-time jobs who would rather be working full-time and 2.7 million people working temporary jobs. If we take all of this data into consideration, the underemployment rate (counting those who are not working the number of hours they would like to work) rose from 13.8 percent in May to 14.3 percent in June.
While long-term rates go up, Fed chairman Bernanke continues to indicate that short-term rates won’t rise until the unemployment rate hits 6.5 percent, not projected until sometime in the second half of 2014.
With bond prices dropping (bond prices and rates move in opposite directions) and volatility driving bond investors crazy, approximately $60 billion came out of the market as investors withdrew funds from bond-focused mutual funds. It could be that some of this capital finds its way into the commercial real estate market as investors search for yield.
All in all, things are still positive from an interest rate perspective for commercial real estate. But if there is one metric for commercial real estate capital market participants to keep an eye on, interest rates should be near the top of the list.