By: Ross Moore, Chief Economist – Colliers International USA
On Wednesday, the Federal Reserve announced a second round of quantitative easing (QE2) in an effort to bolster the economy and ensure deflation doesn’t take hold. This was a somewhat controversial move, with many macroeconomic models showing a $600 billion package would add just 0.25-0.50% to GDP growth and at the same time possibly sowing the seeds for future inflation. For those that follow the commodities market, however, inflation is already here and there may be lessons for us in the property world that can go a long way to explain the aggressive pricing for high quality real estate, despite only mediocre fundamentals.
Rising Commodity Prices – A Harbinger of Things to Come?
Below is the Thomson Reuters/Jefferies CRB Index, a composite measure of 19 different commodities ranging from silver and gold to cotton and, of course, crude oil. The index has increased nearly 22% since mid year sparking fears of rising input costs and ultimately higher consumer prices. The reasons for rising commodity prices are somewhat tied to supply and demand but also to the falling U.S. dollar and also “cheap” money that is emanating from the United States. Wednesday’s second round of quantitative easing was the equivalent of reducing interest rates by a further 50 basis points (not really possible because the Federal funds rates is effectively zero) adding further liquidity to a market that either doesn’t need it, or doesn’t want it. Keep in mind, in contrast to QE1 when mortgage spreads and corporate bond spreads were sky high and the capital markets were largely frozen, today’s markets are operating more or less as normal.
What Does This Have to do With Real Estate?
The point of this analysis is to highlight that with free money (not quite free but at very low cost) asset bubbles are often formed (the 2002-2004 period is a case in point). With the Federal Reserve increasing liquidity and promising to keep the Federal Funds rate low for “an extended period”, hard assets, including commercial real estate, will be a net beneficiary. This goes a long way to explain the dramatic move down in capitalization rates, albeit, only for top quality real estate in select markets, but the trend is clear and is almost certain to continue. This is despite fundamentals that have only just begun to improve and there is little certainty how vigorous the recovery will be. Asset bubbles are often only obvious with the benefit of hindsight but this time may just be different. Commodity prices might just be telling us where real estate prices are headed.
Ross Moore is the Colliers International’s Chief Economist with a focus on providing bottom-up and top-down analysis of commercial real estate markets across the United States. In addition to his North America wide reports, Ross also authors all global research produced by Colliers.