Posted by Christian Hilber and Paul Cheshire, SERC and LSE
QuantitativeEasing (QE) has been pursued by Central Banks in many countries, few
more diligently than in the US and in the UK. Reports from experienced watchers
of commercial real estate suggest this could generate a flood of cheap money – not
into productive investment but into the higher yields offered by commercial real
estate or its liquid versions, Real Estate Investment Trusts. This is
because QE pushes yields on bonds and securities ever further below the rate of
inflation. Such shifts are already said to be visible in the US where the
economy is doing just a bit better than in the UK or Europe. Of course this
pushes down yields in real estate in proportion to pushing up market values.
According to the FT (£) there could already be signs of this in London.
If investors
really believe this low-inflation, low-interest environment is permanent, QE
could well trigger yet another financial bubble. The problem is that such
touted permanent changes in underlying economic relationships seldom are. Parallels
are the supposed ‘step change in productivity growth’ that fuelled the
late-1990s IT bubble or the low real interest rates of the 2000s that created irrational
exuberance in some US mortgage and housing markets. The difference is that this
time, rather than being driven by cheap funding, investment in real estate
equity is driven by QE.
The question is:
what happens when Central Banks roll back QE in two or three years, and money
becomes more expensive? It could trigger a bust in commercial real estate
markets because the real economy does not look as if it is going to be driving
up rents any time soon. In turn, that could damage balance sheets of real
estate companies – and of banks who have lent out the funds in search for a
return. What then?
At the moment these
are just the observations of well-informed insiders and some straws in the wind.
But if this is really happening, then the consequences would be unpleasant
indeed. Not a double dip, not a triple dip, but a triple dip recession followed
by a financial crisis caused by the attempts to kick start the economy from the
first financial crisis. Maybe Central Banks should turn some attention to
evaluating the evidence: where are the funds going? What is happening to real
estate yields? Are any changes observed in these justified by fundamentals in the
economy or are they another bubble in the making?
