The First Round of Quantitative Easing, or QE1, instituted by the Federal Reserve, covered a period from January 2009 to March 2010, and involved the purchase of approximately $1.4trillion of mortgage-backed securities (MBS) and Treasuries.  This did not include the TARP stimulus package which amounted to another $2 trillion.  Theoretically, these stimulus efforts staved off a collapse of the US economy, but this $3.7 trillion rescue package did little to repair the economy.   It did have the visible impact of inflating stock prices, and reducing borrowing rates for homeowners and commercial property owners. 

In early November, the FOMC announced their plans for QE2, which calls for the repurchase of an additional $600 billion of long-term treasuries and another nearly $300 billion in MBS over an eight-month period ending June 2011.  Opinions are divided in commercial real estate circles as to whether these actions will be beneficial or deleterious for the commercial real estate industry over the next decade. 

Nearly everybody agrees that one of the likely results from this move is that interest rates are likely to continue their gradual decline in the near term, just as they did following the QE1 announcement.  Since July, the 10-year and 30-year treasury rates have dropped almost 25 bps based on the rumored announcement of QE2.

The decline in interest rates in the near term should help property owners refinance, bolstering their property returns at a time when rents are continuing to ratchet down with every lease expiration due to weakness in office and retail fundamentals. 

But will the QE2 exercise ultimately lead to inflation or, even worse, deflation in real estate values?  The goal with QE1 and QE2 is to increase inflation slightly.  The CPI increase over the past 12 months was a disinflationary 1.1%, and well below the Fed’s target rate of 2%.  Several of or overseas trading partners, like Germany and China, have been vocal in their opposition to this FOMC strategy. 

Another benefit to slight inflation is that it will help asset values recover, which will be good for performing as well as “underwater” properties and mortgages.  It may ultimately help lenders sell their problem loans at close to par, taking more properties out of the “Pretend and Extend” quagmire which makes it difficult for players at all ends of the investment spectrum to reconcile where real values are today.  Some fear that the hidden goal of inflation is that it hides some of the recent problems, and makes it easier for Washington to avoid making any tough decisions in the near term regarding the budget deficit. 

Ultimately, printing money for stimulus programs alone will not put the economy back on its feet.  There needs to be job growth and increased consumer confidence in order to fill vacant office space and make the cash registers ring loud again.  Without jobs and consumer spending, there is a very real risk of deflation beginning in a year or two. 

The actions have certainly spurred increased investment activity by foreign entities in US properties.  That is to be expected, as the US dollar has declined against most major currencies, and is now at a 15-year low against the Yen.  In the third quarter of this year foreign buyers accounted for almost 14% of major US investment sales in the US, compared to the historical average of 8%.   Most of this investment has been in core assets in gateway cities, but it is believed that there may be a domino effect of future increased activity in the secondary markets, as domestic investors seeking better than 5-cap initial yields are forced to run at higher-yielding opportunities. 

The flip side of the relatively low dollar is that our exports are now much more attractive to overseas consumers.  That should have a positive impact on industrial real estate, including port-related properties and warehouse space in general. 

Bottom line:  the QE1 and QE2 Fed strategy may provide the needed band—aid of lower interest rates, which helps many property income statements look better, but the key fundamental requirement of job growth will be needed to create a long-term improvement in property values.

-Mark De Riemer

Mark T. De Riemer is Senior Managing Director of Investment Services at NAI Global New York City, and is a member of the Investment Services Group.