What Does the End of Quantitative Easing Mean for Real Estate Values?

This past week the U.S. Federal Reserve announced the end to its quantitative easing (QE) program of mortgage-backed securities and U.S. government bonds purchases, which it began in 2008 in an attempt to stimulate the economy by lowering long-term interest rates.

The announcement came as no surprise.

For over a year, the Fed has directly and indirectly signaled that this was coming, in effect pulling the Band-Aid off ever so gently. The immediate market reaction has been very measured, with the 10-year U.S. Treasury yield only up modestly in the last week--less than 10 basis points (bps) as of mid-day on October 30, 2014.

The end of QE is a big step in the recovery from the Great Recession. Although the medium-term effects are difficult to predict at this point, conventional wisdom points to rising interest rates in 2015. Our view is that there are several factors that mitigate the likelihood of a material rise in interest rates in the medium term.

The most notable factor is the recent weakening of the global economy, particularly in the European Union, where a form of QE was recently implemented and additional stimulus measures seem likely. The deterioration in growth in China, which is hurting emerging markets, and some developed economies like Germany is dampening global growth expectations as well. Other factors include the recent rise in the value of the U.S. dollar, which, along with falling oil prices, is helping to suppress domestic inflation.

Global real estate consultant CBRE feels that a material rise in rates remains some way off and the impact on commercial real estate of the recent announcement will be negligible.

To support this, CBRE looked back to the events of May-August 2013, when Chairman Bernanke made the first direct suggestion that the Fed would reduce its bond-buying program, which triggered the "taper tantrum" that caused 10-year U.S. Treasury yield to expand by over 100 bps in the course of four months.

CBRE studied the immediate effect on commercial real estate of the rise in the 10-year U.S. Treasury by looking at actual trades executed by CBRE Capital Markets professionals following the spike. The results showed very modest changes in values, with almost no effect in all asset types except multifamily, which, while small (generally less than 2%), was greater than all other asset types. Commercial real estate proved resilient to a rapid rise in long-term interest rates in mid-2013, and CBRE believes it will be the same over the next several years.

CBRE says there is certainly a strong long-term relationship between long-term interest rates and real estate cap rates. However, the lags are rather long and there are powerful medium-term offsets. For instance, high institutional demand for core commercial real estate against relatively limited supply and good U.S. GDP growth momentum have created positive market sentiment. Most of all, pent-up rent increases across the major asset classes--due to rolling leases entered into during the 2008-2010 time frame and new occupancy demand driven by a growing economy--should bolster cap rate stability, even in a rising interest rate environment.

Other mitigants include geopolitical turmoil, which makes U.S. Treasuries, the "risk free" security of choice, more attractive and keeps rates low, and the increased globalization of commercial real estate financing sources, where some foreign buyers are tapping into financing from their home countries, which have a much lower cost of debt than the U.S., to underwrite purchases.

Also, the good news of a tightening labor market cannot be ignored, particularly for many industries that directly or indirectly affect commercial real estate including trucking, oil and gas, and construction. However, inflation expectations remain low and stable, and short-term rates are likely to move up only very slowly.

Spencer Levy, head of CBRE Americas Research concluded with: "The end of QE speaks to the gathering strength of the U.S. economy and won't affect commercial real estate values."

Federal Housing Finance Agency Unveils Plan to Loosen Rules on Mortgages

For years, politicians, housing advocates and potential home buyers have complained that tight credit policies after the housing market crash have kept too many deserving people from qualifying for mortgages.

Now the government is taking steps that it says it hopes will allow more first-time buyers and lower- and middle-income Americans to get home loans at low rates.

On Monday, Melvin L. Watt, the nation’s chief housing regulator, announced a program offering more reassurances to mortgage banks that fear they could suffer unpredictable losses on the loans they sell to the government.

Separately, he disclosed that efforts are underway to allow borrowers to receive government-backed loans with much smaller down payments than are now required. But contrary to early expectations, he offered few details on such plans.

“We know that access to credit remains tight for many borrowers, and we are also working to address this issue in a responsible and thoughtful manner,” said Mr. Watt, director of the Federal Housing Finance Agency, which regulates the mortgage finance giants Fannie Mae and Freddie Mac.

The move in large part is intended to reassure banks that have had to pay tens of billions of dollars to settle legal cases arising from the housing boom and bust and buy back bad loans sold to Fannie and Freddie. To avoid having to make those payments again, many lenders now demand that borrowers meet stricter requirements for loans, known in the industry as overlays.

“We know that this issue has contributed to lenders’ imposing credit overlays that drive up the cost of lending and also restrict lending to borrowers with less-than-perfect credit scores or with less conventional financial situations,” Mr. Watt said in a speech on Monday to the Mortgage Bankers Association convention in Las Vegas.

Some economists, with mortgage bankers, welcomed the new plan, saying that it, with more gains in the job market and a recent dip in mortgage rates, could put the housing recovery back on track. Ben S. Bernanke, the former chairman of the Federal Reserve, recently told an audience that even he could not get a loan to refinance his mortgage.

“Creditworthy borrowers who have been locked out of the housing market will finally have an opportunity to become homeowners,” said Mark Zandi, chief economist at Moody’s Analytics.

But some housing finance analysts contend that tight credit does not sufficiently explain the weakness in the housing market. Instead, they say, an aging population, stagnant wages and a wariness of taking on new debt have all reduced demand for mortgages.

“The reality is that this is as much a demand-driven drought as it is a credit-driven drought,” said Joshua Rosner, of Graham Fisher & Company, a research firm.

With the new plan, the government is trying to strike a balance between the frenzied years of the housing bubble, when mortgages were approved with little regard for the ability of borrowers to repay them, and the tight grip on mortgages after it burst.

“It requires a lot of fine-tuning to get a national mortgage market that achieves all the objectives we want,” said Stan Humphries, chief economist for Zillow, a real estate website.

To reassure mortgage lenders, the housing finance agency intends to further relax the agreements that determine when Fannie and Freddie may require banks to buy back bad loans. The terms that are being loosened involve loans that show evidence of fraud or other flaws in the underwriting process.

Under the new agreements, for instance, Fannie and Freddie would demand buybacks only when there was a pattern of misrepresentations and inaccuracies in the loans. In addition, if problems are later discovered in loans, the deficiencies would have to be significant enough to have made the loans ineligible for purchase by Fannie and Freddie in the first place.

These changes follow other recent adjustments by the housing finance agency to calm mortgage lenders. But mortgage banks did not increase lending to less creditworthy borrowers.

Now, some housing specialists are more hopeful that the overhaul announced on Monday will prompt the banks to lend more. “It will be helpful in moving the needle,” Jim Parrott, a senior fellow at the Urban Institute, said.

Mr. Watt said he would give specifics in a few weeks about a plan for borrowers that could include down payments of as little as 3 percent.

Borrowers can already apply for low down-payment loans that are backed by the Federal Housing Administration. But housing specialists said that some borrowers who qualified for loans backed by Fannie and Freddie were being directed to the F.H.A., which backs loans that have much higher interest rates.

“You want people to get the loan they qualify for,” said Michael D. Calhoun, president of the Center for Responsible Lending.