Bursting bubbles: has the Fed caused a new crisis?
Signs of recovery began to ripple through the economy by 2010, however tangible results only started to show over the last three years as rapid price hikes and rising transaction volumes swept the country. In the midst of a bull market, American commercial real estate saw billions pour in from major companies, foreign investors as well as insurance and pension funds. This rising tide was not just the offshoot of economic recovery but also the aggressive Federal Reserve policies of low interest rates and quantitative easing (QE).
- The market hasn’t peaked yet: even as prices and volumes rise, there’s still room for growth in specific sectors.
- Investment capital raised by the U.S. government and major international investors has absorbed supply on the market.
- Property development should intensify in coming years but high demand will maintain price and yield growth.
- Demand for commercial real estate is speculative: it does not reflect true economic growth.
After the big bust in 2008, the Federal Reserve reverted to the textbook tactic of dropping interest rates to make loans more attractive. However, it was not enough to reverse America’s recession and under Bernanke, the Federal Reserve launched three successive waves of quantitative easing and trillions of bonds were bought in an attempt to stifle interest rates over the long term.
|QE (2009)||QE2 (2010)||QE3 (2012)||QE terminated (2014)|
|$1.75 trillion bonds are bought in the months following the crash||The Fed buys $600 billion more bonds as growth slumps||Nicknamed “QE Infinity”, monthly bond purchases rise from $40 billion to $85 billion then gradually decrease||October 2014, the Fed finally puts QE to bed after accumulating over $4.5 trillion worth of bonds|
Interest on commercial property dropped to 5% and investments grew. The aggregate volume of this credit has reached the peak level of 2008 at $1.7 trillion, compared to $1.4 trillion in 2011.
Economic recovery has already contributed to growth in value and investors have redirected the available credit to this market because it is more profitable than U.S. Treasury bonds and less risky than stocks. For instance, the average cap rate of New York City commercial real estate is 5.7%, in contrast to 2.2% yields on
Cheap credit contributed to the growth of transaction volume on the commercial property market by 36% in H1 2015 against the same period last year, reaching a total of $232 billion. Investments into commercial property in the U.S. have been growing steadily since 2010 and if it continues at the current rate, the volume of transactions could reach its
The volume of investments in U.S. commercial property will hit $435 billion in 2015, 90% of the 2007 peak, according to global real estate group JLL. Investments in retail and industrial facilities have already exceeded 2007 levels, but office and hotel property still haven’t reached the
Investments and prices have been growing for the last five years. By Q2 2015, prices had increased 78% since that period and current average prices now exceed the
Investors are targeting highly liquid property located in America’s business districts and New York in particular. For instance, office prices in the central business districts have already surpassed the
The situation for retail property, second largest by volume on the commercial property market, is quite the same. While growth is not quite as astounding, retail property prices will surpass the 2007 peak if they gain just another 8%.
Overall, the commercial real estate market is sending clear signals that, despite strong price increases and speculative demand in certain niches, prices have room for more growth.
The market still needs new buildings at this stage of its cycle, contrary to 2007 when it was overloaded. The share of vacant properties has been dropping over recent years and the new wave of demand makes use of the old supply. Much of the commercial real estate commissioned before 2007 was unmarketable during the crisis, but now that demand and prices are growing again, new buyers are purchasing this property.
Despite the slow pace of construction, demand for commercial real estate still exceeds supply and lease rates on office space is rising. This is mainly to the benefit of central business districts where they have gained 22.7% since 2010.
While it’s too early to tell whether it’s a bubble or a chimera but there are certain signs that merit attention. Growing lease rates combined with growing prices prompt investors into construction and speculative purchases of new real estate. This will stimulate growth on the commercial real estate market. If supply exceeds demand, the bubble will burst. However, stricter due diligence in banks has reduced the risk of bad debt.
Nevertheless, current investment demand for commercial real estate is speculative as lending on this market is rising rapidly in comparison to the relatively modest growth of the U.S. economy. Over the last five years, the economy has been growing at 2.2% rather than
High demand for commercial
In many cases, the same major investment funds are both the most active buyers and the most active vendors of commercial real estate, therefore contributing to price growth on the market by engaging in
- While the interest rate set by the Federal Reserve stays the same, the risk of a bubble are low.
- Capital inflow from emerging markets are encouraging overheating on the market.
- The New York commercial property is the most popular and therefore the most at risk.
Ivan Chepizhko, Tranio