It’s easy for real estate investors to get caught up in their own world.
From buying new properties to dealing with property management issues, it’s easy to get lost in the weeds of the day to day.
But it’s important to not lose sight of the macro-level as well, and to be aware of larger trends in the real estate world and the economy as a whole. This is true for both active and passive investors.
To help stay on top of things, I subscribe to several research services, some paid and some free. The commercial real estate brokerage Marcus & Millichap publishes some of my favorite free research, and they published a great piece this week discussing the inflation numbers from April and how they impact the interest rate outlook for CRE.
(In case you missed it a couple weeks ago, April’s CPI came in at 3.4% year-over-year, down from its highs but still well-above the Fed’s stated inflation target of 2%.)
A few things in the research piece stood out to me, so today I want to share some quick but important takeaways.
What is Normal?
Something I’ve been saying for a while is that the definition of “normal” when it comes to interest rates isn’t same for everyone.
Most investors who have only been investing since 2010 or later only know a low rate environment. But for whatever reason, a lot of those same investors never read any economic history, and don’t realize that the period from 2010 to 2022 was an anomaly.
According to the data from Marcus & Millichap, “normal” varies quite a bit depending on the era you were investing in:
| Era | Average Rate |
|---|---|
| 2010-2022 | 2.28% |
| 2000-2009 | 4.46% |
| 1990-1999 | 6.66% |
| 1970-1989 | 9.05% |
Two other relevant data points:
- Over the last 70 years, the 10-Year Treasury, a benchmark rate for real estate, has averaged 4.6%.
- According to Sidney Homer’s book A History of Interest Rates (yes, it’s as dry as it sounds), interest rates have generally averaged 4-5%. And that’s across cultures for thousands of years.
Today, the 10-Year Treasury is around 4.5%, basically in line with historical averages.
So if you find yourself saying “I just wish rates would get back to normal” (or hear a syndication sponsor talking about rates “returning to normal”), realize that we might already be there.
Other Takeaways
A handful of other interesting tidbits from the research piece:
- We’ve been in a declining rate environment since 1981. Anyone under 60 years old has only known a trend of decreasing interest rates for their entire adult life.
- This makes me want to explore a possible correlation to a consistent increase in real estate values over the same time period, but that’s for another time.
- Commercial real estate is adapting to higher rates. Values have come down from the peak (meaning cap rates have also come up from their lows), but the decrease in values has slowed significantly and some CRE sectors are seeing values creep back up.
- Key economic indicators, including employment rate, wage growth, retail sales, and overall corporate profits give little reason to think that the Fed must cut rates right now to avoid a recession.
Final Thoughts
I’m still in the “higher for longer” camp. Until (if?) we really start seeing serious cracks in the economy, I think it’s unlikely the Fed lowers rates more than 25-50 basis points (a quarter to a half percent) over the next year.
So as a passive investor, beware of deal sponsors betting on interest rates to go down in the near future in order to save or make their deals work.
What was once the old normal increasingly looks like the new normal.