Real estate is a highly levered asset class, which means that pricing is sensitive to interest rate changes.
Larry Summers recently published a post on his blog where he argued that the Fed (US) is being far too complacent about their ability to respond effectively to a future recession. He sees this as their biggest monetary policy challenge going forward.
Given the potential impact to real estate and city building as a whole, I thought I would summarize some of his key points:
Private sector GDP growth in the US averaged 1.3% over the last year
Since the 1960s, this level of tepid growth has typically foreshadowed a recession
Larry sees > 50% chance that the US economy will enter a recession in the next 3 years
400-500 basis points of monetary easing is usually needed to counter recessionary pressures
The Feds will likely not have this much room to play with when the next recession comes along
I don’t think anyone could have predicted that rates would remain so low for so long. (10-year Treasury = ~1.6% at the moment.) Still, my view has been that rates in Canada and the US won’t be posting meaningful increases anytime soon. And Larry’s post reinforces that for me.
What’s your view?
This morning, I am looking at the following chart of average home prices in the Greater Toronto Area:
It’s from this Globe and Mail article.
These are staggering numbers. The average price of a detached home in the suburbs (905 area code) increased 21% year-over-year. In the city (416 area code), the increase was 19.6% YOY. These numbers are almost unbelievable.
The article focuses on low supply (decrease in listings) and high demand. And that is certainly a big part of what’s going on here in this city, as well as in many others.
But of course, the backdrop to all of this is our low / zero / negative interest rate environment.
Larry Summers has a great post on his blog (which I discovered this morning via Fred Wilson) that talks about this “remarkable financial moment.” In some instances, real interest rates are actually negative! (You should read his post.)
There are always people threatening that interests rates just have to go up. But Larry, as well as others, continue to argue that natural real interest rates are likely to remain close to zero going forward.
Fred mentions Albert Wenger on his blog this morning and I have written about him before as well, here. In his book World After Capital, Albert argues that capital is no longer the scarce resource of our time. Instead, it has become attention.
If you believe all of this to be true, then perhaps the numbers at the top of this post aren’t so unbelievable after all.