The Inverted Yield Curve’s Effect on CRE
The recent yield curve inversion may raise concerns about a potential recession, but it is unlikely to harm commercial real estate investors.
Investors normally demand a higher interest rate to buy longer-term bonds, but on Wednesday three-month government bonds paid a higher yield than 10-year bonds. Historically, some analysts said, such an inverted yield curve generally precedes an economic downturn.
But Mortgage Bankers Association Chief Economist Mike Fratantoni said the U.S. economy remains relatively healthy, especially compared to countries in Asia and Europe. “U.S. job growth has slowed a bit but it is still reasonably strong and wage growth is moving ahead though it has leveled out,” he said. “The level of job openings seems to be dropping but it’s still very high. So the U.S. job market still looks pretty good.”
To the extent the U.S. economy remains stronger than other economies and investors see commercial real estate as relatively immune to economic uncertainty, “that can buoy investor interest in U.S. commercial real estate,” said MBA Vice President of Commercial Real Estate Research Jamie Woodwell. “The fact that U.S. commercial real estate is a relatively liquid dollar-denominated asset with leases in place and income could put it in relatively good stead in the event of a recession. You see that in things like real estate investment trust stock performance: when there are questions about interest rates the dividends from REITs are sought-after by investors.”
On the financing side, lower interest rates support demand for commercial and multifamily mortgages, Woodwell said. “Given where the yield curve is right now, it’s likely there is some interest in locking in longer-term rates while a borrower can,” he said.
Woodwell said dropping interest rates do not necessarily result in dropping cap rates. “What one needs to look at is what is driving the changes in interest rates,” he said. “To the degree the drop in longer-term interest rates is coming from investor bearishness, that might lead to cap rates remaining at current levels rather than chasing interest rates down. It all depends on the degree to which investors view commercial real estate as a risk-off investment or a risk-on investment.”
Fratantoni noted certain markets such as New York and San Francisco that rely on capital flows from abroad to support their commercial markets could benefit from a strong U.S. dollar relative to other currencies. “Right now the European Central Bank is about to institute another round of quantitative easing,” he said. “Banks all around the world are cutting rates more quickly than the U.S. Federal Reserve is, which is leading the U.S. dollar to strengthen. That might be another reason why the commercial market could be supported, because it represents another way for foreign investors to retain the purchasing power of their capital.”
