Colorado Real Estate Journal - December 17, 2014
At this time last year, the consensus was that long-term rates would continue their ascent and we would see a gradual return to a normalized interest rate environment. The 10-year Treasury at year-end 2013 was 3.03 percent, an increase of approximately 140 basis points from May 1, 2013. The expectation was that 10-year Treasury yields would continue their rise above 3 percent in 2014. However, from Jan. 1 to Oct. 3, 2014, a 59 bps decrease in the 10-year Treasury was realized. There are various factors that have influenced the current rate environment, including Fed policy, bank liquidity regulations and geopolitical tensions. Since the beginning of 2014, the U.S. Federal Reserve steadily reduced its monthly purchases of U.S. Treasury bonds and mortgage-backed securities from a peak of $85 billion to $15 billion per month, signaling a gradual end to its quantitative easing program. In October, the Fed announced the official end to QE while committing to keeping low interest rates for “a considerable time.” The Fed has stated that it will likely maintain the zero percent to 0.25 percent target range for the federal funds rate despite the end of QE. Additionally, the effects of QE will persist even after bond purchases end. The Fed currently has approximately $4.4 trillion in assets and will continue to own all of the bonds it purchased during QE. Reducing the supply of Treasury bonds in the market resulted in higher bond pricing and lower yields. The Fed isn’t expected to start shrinking its portfolio until after it starts raising the federal funds rate. At the same time the Fed initiated a reduction in bond purchases , U.S. banks were accelerating their purchases of U.S. Treasuries. The U.S. regulatory implementation of Basel III and the Dodd-Frank Act represents a change in capital standards. The new regulatory requirements are meant to strengthen capital requirements by increasing bank liquidity and decreasing their leverage. As a result, banks are now held to increased liquidity ratio standards. Accordingly, banks have undertaken unprecedented purchasing of U.S. Treasuries. U.S. banks acquired $71.99 billion of U.S. Treasuries in the third quarter of 2014, a 26.32 percent increase from the previous quarter. These institutions have added $185.8 billion in U.S. Treasuries the past year, a 116.35 percent increase, and are now holding a total $345.49 billion of U.S. Treasuries. To some the QE taper was an illusion and the only material change was the buyer of the Treasuries. Geopolitical tensions and weak foreign economies have caused a flight to safety in the capital markets. In 2014, the world has experienced the Ukraine crisis, the imposition of sanctions against Russia, the military success of ISIS in Iraq and Syria, the escalation of the Israeli-Hamas conflict in Gaza and the outbreak of the Ebola epidemic. Furthermore, European economies such as France, Germany and Italy have demonstrated weak economic performance. Growth for the 28-member European Union is expected to be only 1.3 percent in 2014, with little improvement forecast for 2015. The European Central Bank, though much later to the party than the U.S. Fed, has only recently decided to expand its balance sheet to inject a lifeline into the region’s economic growth. Asia also has experienced slowing growth. Persistent geopolitical risks influence investor fear with the resulting increase in demand for safe investments like U.S. Treasuries. It is difficult to predict where rates will be at this time in 2015. What we do know is that rates are low by historical standards. The 50-year average 10-year U.S Treasury is 6.48 percent, compared with 2.35 percent at the end of October. Lenders, including life insurance companies, Freddie Mac, Fannie Mae, commercial mortgage-backed securities and other sources, have been active in 2014 and this is expected to continue into 2015. Interest rates for commercial mortgages mirror the historical low Treasury yields, and attractive long-term fixed-rate financing remains readily available. Several life insurance companies along with Fannie Mae offer payment terms from 10 years up to 30 years fully amortizing at attractive fixed rates. For those who want to maintain flexibility, various floating-rate options exist. To borrow a baseball metaphor, we are not only well into extra innings, but are in extra innings of the second game of a doubleheader in this low interest rate environment. Owners of commercial real estate will continue to be the beneficiaries of this state of affairs.