Quantitative easing is a common topic in business news, but its impact on the commercial real estate market is less well known.
It is a system of unconventional financial policy in which a dominant bank or Central Bank purchases lasting securities from the open market to increase the supply of money and encourage loaning and investment. Doing so adds an infusion of money to the economy and lowers interest rates.
How Quantitative Easing Applies to Commercial Real Estate
QE has a big impact on the development and investment of commercial real estate. As soon as the cost of money escalates, developers and investors have to determine if an investment will produce a positive return on investment.
QE also decreases interest rates, particularly mortgage interest rates. Central banks generate demand for mortgage-backed securities, by acquiring ties of varying durations. The increase in demand places downward pressure on interest rates.
Lower interest rates make buying real estate more affordable and in turn the demand for real estate properties increases.
Special Circumstances for QE in Commercial Real Estate
Central banks frequently apply quantitative easing policies when their key interest rates get to zero, a situation also described as “zero lower bound.” It encourages a “liquidity trap” where individuals hold cash. In a situation like this, financial authorities may use quantitative easing to stimulate the economy.
Quantitative easing can save the economy from recession ensuring that inflation does not fall under the central bank’s inflation target.
Example of Quantitative Easing in Commercial Real Estate
In 2008, the Federal Reserve introduced quantitative easing in America. In the first phase of QE (2008-late 2010), the Fed purchased roughly $1.3 trillion of bank debt, mortgage-backed securities (MBS), and Treasury securities. During the second phase, QE2 (Nov. 2010-June 2011), the Fed purchased $600 billion of Treasury securities only.
After a break that lasted for a year, the Fed commenced the third phase, QE3 (Sept. 2012) purchasing only MBS off the books of banks. It commenced with $40 billion a month, then increased to $85 billion per month. In June 2013, the Fed announced a tapering off to $65 billion a month. The capital markets responded undesirably to the declaration; so the tapering was postponed till December 2013, when it dropped MBS monthly purchase rate to $75 billion. In 2014, the Fed became persistent in its reductions of $10 billion monthly, and, at the end of April, the monthly purchase was down to $45 billion.
Quantitative Easing is Great for Sustaining Interest Rates, Less for Expanding Lending
Quantitative easing has contributed to sustaining interest rates at historically low levels, but it has not led to the expected increase in industrious lending to finance economic evolution. However, in terms of commercial real estate, lower interest rates and scarcity of new debt issuance have contributed to lower real estate cap rates and bringing about higher values of investment real estate.