Einstein died and was immediately wafted to Heaven where St. Peter welcomed him warmly. “Alas,” said St. Peter, “your suite is not quite ready. So may we invite you to relax in the ante-room for just a bit ? …
But to help you pass the time, we have a young lady here with an IQ of 170 who can discuss with you your Theory of Relativity.” “But if that’s not satisfactory,” said St. Pete, “we can send out a young fellow with an IQ of 180 who can discuss with you your Unified Theory. And if that’s still not adequate, we have someone with an IQ of 75 who can discuss with you the future of interest rates.”
The matter of interest rates is of great interest to most investors, but it is of very special interest to the Federal Reserve bank whose primary charge is to manage inflation and support full employment. The Fed has a number of tools to accomplish this, but perhaps the most important is the control of interest rates.
Following the collapse of the stock market, Mr. Greenspan on Dec. 16 , 2008 lowered the Federal Funds Target Rate (FFTR) from 1.0% to 0.0% – 0.25% in an attempt to stimulate the moribund economy. Subsequent maneuvers by Mr. Bernanke (of helicopter fame) resulted in a series of Quantitative Easings ( e.g. QE1, QE2,QE3) whereby the Federal Reserve, in an effort to inject liquidity into the market, acquired mortgage bonds from banks as well as U.S. Treasuries. This artificially maintained rate resulted in significant inflation in the prices of assets of all kinds, not the least of which has been the price of commercial and multi-family real properties, which are now seriously overpriced.
In Dec. 2015, the present Chair, Janet Yellen, raised the target range to 0.25% – 0.5%. Unfortunately, inflation has not been contained at the levels which the Bureau of Labor Statistics publishes (2.1%) and Ms. Yellen was pressured again by rising inflation rates to increase the target range in Dec. 2016 to 0.5% – 0.75%, suggesting again that 3 increases were possible in 2017. Co-Chair Stanley Fisher volunteered that as many as 4 increases in rates were possible in 2017. Ms. Yellen may have been constrained in her prediction by the memory of the drop in the Dow Jones Index by more than 660 points in Jan. 2016 following the Dec. 2015 increase.
Although the FFTR is an important metric for a number of other rates which use it as a base rate, interest rates for commercial properties rely much more on the 10-year Treasury note rate which has doubled from 1.30% in October 2016 to 2.60% in Feb. 2017. This increase of 130 bps suggests that the “safe rate” is now greater than the BLS  inflation rate, which underscores the lack of validity in BLS numbers.
This increase spells trouble for many mortgaged properties whose low interest rate was established for loans over the last 5-8 years. A large number of commercial loans call for adjustments in the interest rate at 5-year intervals. The adjusted rate for renewals is usually determined by a spread, or margin, over the 10-year rate with an allowance for risk. As the 10-year rate increases the total rate (including an allowance for risk) also increases.
In addition to more expensive mortgages, an increase in the “safe rate’ also presages an increase in the capitalization rate, and therefore a decline in market value.
Consider an income property whose value of $4M was established by capitalizing its net operating income of $200,000 @ 5%. An increase of 50 bps (0.5%) in the capitalization rate indicates a value of $3,636,363, a 9.1% decline. An increase of 75 bps (0.75%) reduces the value to $3,478,261, a 13% decline in investment value.
President Trump is known to favor higher interest rates and while he has not ventured any information affecting real estate values, it is fairly certain that mortgage rates will increase and market values will decline. The year 2017 is very likely to be a turbulent year for commercial real estate, but also an opportunity to take advantage of falling prices.
Even Einstein would probably agree.
 Bureau of Labor Statistics: http://www.bls.gov
When a property is leased employing a ground lease, two separate interests are created: the first is the leasehold interest, held by the tenant; the second is the leased-fee interest, held by the landowner/lessor. What is unique about properties subject to a ground lease is that the lease conveys to the first tenant not only the right to use and possess the property but also the right to develop it, subject to the terms of the ground lease.
Once the property is improved, the leasehold interest may be transferred to a new owner who acquires title to the improvements. The leased-fee owner may also transfer title to a successor-in -interest, but the title transfers subject-to the ground lease.
At expiry, virtually all modern ground leases provide that the improvements on the land revert to ownership by the landowner/lessor. During the term of the ground lease the landowner is said to hold an estate in reversion, which is the leasehold interest which awaits him/her at expiry. Continue reading
A Real Estate investor who is contemplating an exchange of a fee-simple property into a leasehold interest (ground lease) property needs to be careful that the new or remaining term of the ground lease, together with available options to extend the lease, totals at least 30 years. Continue reading
The United States is beset with many severe financial problems, not the least of which are the looming collapse of the Social Security System, an expanding public debt of $20+ Trillion and the impending collapse of Medicaid and the Affordable Care Act (Obamacare). But perhaps the greater threat to the financial health of the individual American is the enormous unfunded liabilities that continue to be accrued not only by the federal government but also by states, cities and municipalities of varying sizes which are contractually committed to funding the retiree’s pension payments.
In 2013 Moody’s estimated that the shortage of funds available for federal pensions, civilian, and military employee benefits amounted to $3.5 Trillion. The Director of the Congressional Budget Office, Keith Hall, recently estimated that the state public pension plans are now unfunded by $4.7 Trillion. Total unfunded liabilities now exceed $9.2 Trillion.