A look at the market shows housing fundamentals are primed to withstand the looming U.S. interest rate increase
By RICHARD HILL ADAMS
The Federal Reserve Bank Chairwoman Janet Yellen is prepared to boost the Federal Funds Rate a quarter of one percent at the December 2015 meeting. This is predicated on the Feds desire to start to increase short-term rates which have been at 0 percent for the last seven years. The short-term rates will be going up, not fast, but at the speed of which the economy improves over time with more jobs being created and economic prosperity in the country. The unemployment rate stands at 5 percent—a typical full employment rate. However, it lacks solid paying middle-class jobs that created a better standard of living with higher incomes that we saw in prior economic cycles.
The Fed may be in charge of the short-term rates in the U.S., but we also need to recognize that we are an interdependent economic society tied together by the speed of light by the computers of the global financial world. The economic action in Frankfurt will have an impact in New York and around the world that we live in today.
Due to the worldwide economic issues, long-term rates continue to stay low. The overseas economies are weak, the dollar is strong, and wages are rising slowly with inflation below 2 percent, the Federal Reserve Bank’s target.
The 10-year Treasury bill is at about the same place it started in 2015—just a little over 2 percent. Consequently, while the Fed may control the short-term rates, long-term bond markets are firmly in control of their market and the rates.
As the Federal Reserve Bank is poised to increase the Federal Funds Rate from 0 to .25 percent, it is important to recognize that the Mean Fed Funds Interest Rate historically has been 1.25 percent. It may take time for the Fed to achieve the mean rate again, but at some point in the future returning to the mean would give the Federal Reserve Bank more flexibility in dealing with the economy. If the economy turns down in the future, the Fed would have the option of reducing the federal funds rate to stimulate the economy and spending.
As we look at the market, housing fundamentals appear primed to withstand the looming U.S. interest rate increase. Home sales hit a nine-year high in May 2015. Commercial real estate markets are expected to increase their production by 12 percent over 2014. All of the facets of the real estate development industry appear to be hitting on all cylinders. New homes are in high demand and the millennial market is looking for that new and exciting multi-family product that provides mobility and options. The industrial markets are incredibly tight, big box distribution facilities are being built on a speculative basis with tenants being lined up as the concrete slabs are being poured. Retail has definitely not gone out of style due to the Internet and is an extremely healthy component of the real estate market today.
Interest rates for housing have risen and retreated over the last year with permanent fixed-rate loans at 3.8 percent today. Credit has also been loosened at Fannie Mae and Freddie Mac; all of this will inure to the benefit of homebuyers.
For the development of multi-family products there are fixed-rate construction loans converting to permanent loans at 3.25 percent interest rates in today’s market. There is a tremendous resurgence to redevelop the downtown areas that bring new life and vitality to communities, which were once stagnant and out-of-favor with the consumer.
Solid economic drivers continue to promote healthy real estate development activity. Low oil prices have kept a firm rein on costs for construction, logistics, and manufacturing, even when balanced out with rising labor costs.
The re-regulation of the financial markets by Dodd-Frank will continue to have impacts from house loans to commodity trading and construction financing. Lenders are adapting to the realities and will continue to find ways to facilitate financing for real estate.
The macro-economy of the country is improving, faster in some locations than others, but overall it is improving. The economic recovery from the debacle of 2009 has been long, slow, and arduous. This is a journey that we have embarked on, and one that we will continue to travel over for years to come. We will not see a recovery in the typical sense with housing leading the way and the jobs multiplier having a positive impact for everyone quickly; this will be more like the tortoise recovery—a long slow road ahead.
Richard Hill Adams is the Chairman and Chief Executive Officer of American Realty Capital Advisors. He may be reached at