Central Banker Rosengren on Possible CRE Bubble

Now that interest rates might rise next month, prognosticators are gearing up to predict what will happen next.

Now that interest rates might rise next month, prognosticators are gearing up to predict what will happen next. One line of thinking is that the markets will collectively shrug and go about their business, so long has the increase been anticipated. After all, it probably won’t be much of an increase, and everyone’s already either acquired capital at the low price, or priced an increase into future deals—include various kinds of commercial real estate deals. In any case, it won’t be a big deal, after a wobble in the equities markets on the day of the announcement, because investors and their computerized investment algorithms are notoriously skittish.

Another line of thinking has it that the aftermath of long-term interest rates will in fact have an impact—especially on commercial real estate—and not a particularly good one. Eric S. Rosengren, the president of the Federal Reserve Bank of Boston, outlined a potential problem for the industry earlier this week in a speech to the Newport County Chamber of Commerce in Portsmouth, RI. “One potential cost of maintaining the federal funds rate at the zero lower bound for a long time is that it may incent behavior that would be discouraged in a more normalized interest rate environment,” Rosengren said.

That is, during a period of very low interest rates, “investors seeking a higher return may take on too much risk in order to improve returns, perhaps not fully taking into account the higher risk that normally accompanies higher yields,” the central banker noted in the usual sort of cautious-speak that central bankers use. As that applies to commercial real estate, it means that many developments’ and acquisitions’ main virtue was that they offered a better return—at least for the time being, in the time of low interest rates—than investments tied to low interest rates, such as low-risk Treasuries and the like.

The Boston Fed president continued: “Early signs of this ‘search for yield’ may be showing up in the commercial real estate market… the path of commercial real estate prices have grown quite rapidly, despite the only modest growth in real GDP over the recovery.” He warned about some local markets in particular (in New England, out of consideration of his position): “When the number of cranes observed on a short walk in a city such as Boston reaches double digits, as is the case today, it is worth reflecting on the sustainability of the growth.” In short—and in non-Fed language—too much cheap money for too long might well have created a CRE bubble. Will even a small rate increase pop the bubble?