How Interest Rate Policy Will Impact Apartment Investment

by | 23 June 2015

Last Wednesday, June 17, the Federal Open Market Committee (FOMC) completed its fourth of eight scheduled meetings for 2015. Remarks following the meeting were both measured and conclusory: near-term accommodative monetary policy will remain unchanged. The Federal Reserve, FOMC and Janet Yellen remain skeptical about the US economy.

Also: Two essential concepts for apartment investing | It’s no time to panic in the U.S.

As apartment investors try to glean certainty as to a lending environment highly impactful to acquisition and/or disposition underwriting and asset operations, the tea leaves are more certain than most will admit: Interest rate changes will have little near-term impact on apartment investment.

Plus: Human nature and the successful apartment investorApartment investment in Seattle is a safe bet

What will inspire the Federal Reserve to raise interest rates?

Over the last half-decade of quantitative easing and accommodative monetary policy, the investor community at large has grown accustomed to varying and sometimes confusing guidance from the Federal Reserve. Eventual upward pressure on interest rates was at times tied to unemployment metrics, and others to wage inflation. The most recent guidance from the Federal Reserve provided the latest critical path to a theoretical rate hike:

  1. Further improvement in the labor markets – maximum employment (What does that mean?)
  2. Meeting or exceeding 2% target inflation fate

How close are we to bridging the gap to higher interest rates? Not close. Let’s recap current macroeconomic conditions or at least those that the Federal Reserve and FOMC participants are watching to signal “correct” timing to raise interest rates:

  • Job Growth: Increasingly positive yet exhibiting foreboding cyclical weakness
  • Consumer spending: Dismal GDP growth in Q1 2015 with non-encouraging forecasts into 2016
  • Energy prices: Weakness not seen since 2008; slow recovery predicted
  • Inflation: Weakness further tampered by low energy prices
  • Exports: Declining as unintended consequence of strong dollar and weak global economy

Given the aforementioned conditions, one may conclude the nation is in dire straits — or at least not in a position to immediately raise interest rates. Such a conclusion, at least the latter part, is absolutely correct.

Should market conditions remedy to the point of a rate hike, don’t expect immediate rate movement. The following remarks by Yellen is of particular importance: “Interest rates will remain highly accommodative for quite some time after any initial adjustment in rates.” Read that to mean: Even if we raise rates, it will be done slowly over a long period of time. So much for Volcker-esque rate tactics employed in the early 1980s.

Seattle in a class of its own

In Seattle, and for close-in markets participating in or drafting Seattle’s fundamentals, economic conditions are near counter to that of the nation. If national monetary policy was fixed to Seattle metrics, accommodative monetary policy would have abated three years ago.

While the Federal Reserve and FOMC measure national unemployment in ticks on either side of 5.5%, May 2015 payroll figures demonstrate an unemployment rate in Seattle of 4.1%. Nation-leading employment growth is validated further by another 3,500 jobs added last month – resulting in Seattle-Bellevue-Everett MSA job creation totaling 61,700 year-over-year, equating to 4.0% growth. Seattle’s job growth (or, in Fed terms, “labor market improvement”) is miraculous compared to tepid sub-1.5% employment growth nationally.

Turning to the Fed’s second bellwether of economic vitality: Inflation in the Seattle region is alive and well. Look no further than a mandated $15.00 minimum wage (the envy of less vibrant cities currently weighing $15.00 minimum wage proposals). Rent inflation supported by strong absorption metrics is yet another signal of an inflationary environment far from necessitating cheap money to spur spending.

Seattle is truly countercyclical in this regard. Accommodative rate policy is helpful to buyers and borrowers alike, yet concomitant low cap rates and thin investment spreads continue to challenge return thresholds easily met in less vibrant markets.

What to expect in the near term

Don’t expect much interest rate change at all. Truly. Following the FOMC meeting, two prominent Wall Street firms predicted interest rate adjustments in the near term: Goldman Sachs’ research report was titled “December Liftoff,” while, nearly simultaneously, JP Morgan Chase & Co.’s economic research team distributed a report titled “Fed Draws Dotted Line to September Hike.” September? December? Q1 2016?

Yellen summarized a scenario of a target Federal Funds Rate of 1.75% by the end of 2016, then adding 100 BP over 2017 to close the year at 2.75%. Such a scenario is a downgrade from a predicted Federal Funds Rate of 3.75% by 2017, previously noted by Yellen earlier this year.

My hypothesis: No appreciable change in 2015 then adding 25 to 50 BP in 2016. The 10-Year Treasury constant in 2014 was 2.50%. Based on current rates and my hypothecated rate increase, 18 months from now interest rates will be no higher than they were 12 months ago.

Base your investment decisions on a solid investment thesis for current conditions with the expectation that rising interest rates will be tied to inflation – on offsetting revenue generation scenario. Seattle will continue to outpace the nation, and for the time being, low interest rates will accrue to Seattle’s benefit given the area’s stellar economic fundamentals.

Dylan Simon is a hobbyist technophile and self-taught urbanist. For more, follow his blog and connect with him on Twitter and LinkedIn.