Real Estate in Context: Interest Rates, Stagflation, Inflation and Monetary Policy

February 8, 2022

Real Estate in Context: Interest Rates, Stagflation, Inflation and Monetary Policy

February 8, 2022

Inflation, interest rates, quantitative easing, stagflation and more. We cover these topics in more detail in our latest white paper, ‘Real Estate in Context: Interest Rates, Stagflation, Inflation, and Monetary Policy.’  Let’s break through the noise and determine what these buzz words really mean for real estate.

At a glance

  1. Interest rates are forecast to rise. The Fed’s dot plot suggests three hikes in 2022, and three more in 2023. We found that it takes about six quarters for changes in the central bank interest rate to impact leveraged apartment returns.
  2. The Federal Reserve has discontinued its use of the term “transitory” when describing inflation. We agree this was a good move given seven consecutive months of inflation above 5%, as of December 2021.
  3. The Fed’s pandemic-era asset purchasing program is scheduled to end March 2022. So far, there’s been no ‘taper tantrum’ like the one in 2013. Even if there was a psychologically driven ‘taper tantrum,’ it would likely subside quickly as did the one under then-Chairman Bernanke.
  4. The prospect of 1970s-style stagflation is certainly a concern to the market, but we consider this risk improbable. We studied equity and real estate performance under periods of ‘quasi-stagflation,’ a loosely defined period of heightened inflation alongside suboptimal growth in real economic output. We found that private apartments outperform on an inflation-adjusted basis during times of ‘quasi-stagflation,’ as we defined it.
  5. The 10Y breakeven inflation rate, a market-implied measure of expected inflation, is a far better indicator of movements in the 10Y Treasury yield than actual inflation.

Changes in the EFFR affect leveraged apartment returns

Augmenting decision-making is challenging, but leaving room for time delays in market analysis can be immensely helpful. We determined that changes in the effective federal funds rate (EFFR), the most influential interest rate in the U.S. economy, are most correlated with changes in leveraged apartment returns six quarters later. We employed the same analysis to find that accelerations and decelerations in the Fed’s balance sheet are most related to changes in leveraged apartment returns five quarters later. The takeaway here is that it appears to take five to six quarters for changes in monetary policy to impact leveraged apartment returns.

And what about stagflation?

Some worry that the emergence of the Omicron variant, alongside persistent inflation, may eventually drive the U.S. into a period of stagflation – high inflation coupled with stagnant economic growth. The U.S. experienced stagflation in the 1970s, but the availability of data is sparse, so we need to be more creative when thinking about this particular risk.

We studied the performance of equities and private apartments during times of ‘quasi-stagflation,’ a term most recently used by the People’s Bank of China to describe the nation’s economy. In our analysis, ‘quasi-stagflation’ is defined to be a period where inflation exceeds 3% and the change in real GDP is less than the prior period. (A quick tangent: stagflation of any kind is remarkably unfavorable; the monetary policy tools employed to reduce inflation and spur growth are antithetical to one another. Generally, a win for combatting inflation is a loss for growth, and a win for growth is a loss for combatting inflation.) Using ‘quasi-stagflation’ as a proxy, we found that during such periods, inflation-adjusted private apartment returns far outperform equity counterparts, both on the broad and tech-heavy sides. Although the U.S. economy is not considered to be in a period of actual stagflation, since 3Q11 we have experienced the first period where the U.S. economy satisfies our definition of ‘quasi-stagflation,’ and we did not engineer the definition to make that happen.

We also found that leveraged apartment returns remain stable regardless of the inflation environment we are operating within. Average leveraged returns are rather constant across inflation environments spanning (1) 1%-4%, (2) 4%-7%, and (3) > 7%.

There are many data points to consider when assessing the real estate market right now, but I am reassured with every analysis that apartments remain among the strongest of choices in the real estate asset class. Our team will continue monitoring the situation, and we encourage you to reach out to us with any questions.

-Noah Stone, Economic Analyst