How Long Can Apartment Cap Rates Stay This Low?
@Sean S. started a great thread warning about overpaying for real estate assets which included comments about the apartment market cycle. Because of what the Fed has (and hadn't) been doing to the economy I believe that the peak in this cycle could go on 'for an extended period' to use the Fedspeak terminology. Here is my comment from the thread:
@Sean S. and all;
Great thread, the issues discussed here are generally reserved for the wonky econ people I follow.
A piece I was quoted from in Multifamily Executive Magazine The Apartment Market Cycle Peak Is Here, It’s Just Not Evenly Distributed Yet said domestic investors particularly retirement money (think pension plans) looking for yield or returns of any kind are in a tough spot. How much new money do you want to put to work in the stock market at these valuations, six years into the bull market?
On the fixed income side they’re getting a pittance and I believe the Fed is trapped and we are turning Japanese*. With economies outside the US slowing, exports getting more expensive in their destination currencies and ever cheaper (in exchange rate) outsourcing costs it’s hard to see how we’re going to generate much wage growth and/or inflation that would spur the Fed to raise rates materially. Based on that I believe the cap rate spreads can hold much longer than anyone expects. Remember that everyone has ‘known’ that rates are going up every year for three years now and I don’t think the fundamentals have changed that much.
One other thing that's happening is that the hits to economic indicators from falling oil prices show up almost immediately while the related boosts from cheaper energy costs will take longer to filter through into the data so our domestic economy as measured by GDP will look softer than it actually is for a while. If you're at the Fed though looking at aggregate data for the country as a whole you can't ignore what the data is telling you.
* Japan’s lost decade or Ushinawareta Nijūnen began after the collapse of their real estate and stock market bubbles in 1989/1990 which means it’s old enough to be graduating with a master's degree this year. Unfortunately for us our government and the Fed are following the exact same game plan of protecting the banks and helping them to hide their insolvency at the expense of the economy, especially down at the Main St. level. That’s why I believe this apartment cycle will have an extended peak similar to the illustration above or How I Learned to Stop Worrying and Love The Bomb Low Cap Rates. If you want to have déjà vu all over again read the Wikipedia page Lost Decade (Japan). For a deeper look see the NBER report: The Causes of Japan’s “Lost Decade”: The Role of Household Consumption. And then there was that Vapor’s song from the ’80s
Comments (5)
Giovanni:
Interesting read and a similar scenario taking stage to your north as well. Pundits, and the BoC itself, were nodding towards rate increases of 0.5 to 0.75 over the course of the year in early January. Then oil prices plunged, putting the petro-Loonie into a spin and the next thing you know the BoC announces a 0.15% rate reduction (to 0.75%) of the overnight rate.
Here in Canada there has been precious little wage growth for almost two decades now and households do not have the same purchasing power they did when The Vapors were emanating from your car radio.
Roy N., over 9 years ago
Hi Roy, sorry to hear about the petro-Loonie, I'm just across the border in Bellingham, WA and I know traffic is down at the border, at the airport and at the local Costco too. Do you think it will have an effect on those 2% apartment cap rates in Vancouver?
Giovanni Isaksen, over 9 years ago
Giovanni:
But wait, there's more. At a 2-3% CAP rate you get the pleasure of purchasing an apartment building with a 1950s - 1960s nostalgia ... since that is the last time it was renovated.
Yes, Vancouver is in its own class of silly pricing these days. I think if we get a couple of small nudges in interest rates, it will take some of the hot air out of things ... we can only hope.
Roy N., over 9 years ago
And then there's this from Susan Persin, Senior director of research at Trepp, writing in Urban Land, the ULI's webzine [emphasis mine]:
Still, underlying real estate fundamentals are solid, and the Fed has indicated that it likely will not raise interest rates before fall. These positives should drive further growth in the sector this year.
See her whole piece here.
Giovanni Isaksen, over 9 years ago
Remember last week when (almost) everyone knew that rates were going up? Well here's proof that the Fed is trapped holding interest rates low because there isn't enough strength in the economy to withstand higher rates. Nevermind that some economists believe that the economy is weak because interest rates are artificially low, but that's for another post.
Here's Tim Duy's take on the latest Fed Statement [emphasis mine]:
See Tim's blog here: http://economistsview.typepad.com/timduy/2015/04/fomc-snoozer.html
It remains to be seen just how transitory the Q1 weakness turns out to be as on the one hand bad weather back east, port strike in LA and the hits from the oil industry pullback, and on the other weakening demand world-wide, a rising dollar and people here seem to be banking or paying down debt with their energy savings instead of spending them.
Some observers have pointed out as we get towards the end of summer we'll be in election mode when the Fed rarely if ever raises rates, meaning that the long anticipated rate hikes won't come until 2017 at the earliest.
Giovanni Isaksen, over 9 years ago