Usually, when they are low, interest rates aren’t much of a concern for most people, especially for average people who aren’t investing money or running a business. When inflation is on the rise, even if a family isn’t borrowing to start a business, increases in interest rates by central banks can have a serious impact on every day expenditures and for families with less money, dim their future prospects of saving money or financial advancement. In the United States, the interest rate for banks moving money around is set by the Federal Open Market Committee of the Federal Reserve Bank (FOMC). The FOMC meets 8 times a year, and its meetings have been watched like a papal conclave this year for any sign that the FOMC will adjust rates down.
While the FOMC doesn’t set interest rates on every day lending or your credit card, the effect its decisions have on the whole economy are significant. In a 1955 speech, Federal Reserve Chair William McChesney Martin Jr. made the now famous analogy that the job of the central bank is to remove the punchbowl just as the party starts getting out of hand; lowering rates can act as fuel for more spending and investment and raising them as a break. Inflation has moved through the economy like wildfire since the pandemic, a fire set by impacts of Covid on supply chains and massive government spending to prevent a depression.
I had an exchange with J. David Kelsey, co-founder and Managing Principal of Hamilton Point Investments LLC, a 15-year-old real estate private-equity firm with over $3.5 billion in multifamily direct investments. Kelsey’s observations make so much sense to me I don’t have much comment other than in my questions. I will say that trends in the housing economy that some people don’t like – investors buying land and housing – are a feature of broader trends in the market, not greed. Money goes where there is opportunity, and unless local governments loosen restrictions, lack of supply means higher prices and rents making buying up real estate a better investment. More housing would benefit consumers, especially those with less money and eliminating regulatory barriers to the market would be key to boosting supply, even with high inflation and rates.
HPI’s view is that there should be no interest rate cuts in 2024. Doesn’t this view conflict with conventional wisdom that interest rates are hurting the overall economy?
To clarify, we were not advocating for no interest rate cuts in 2024, simply expecting that there will be none due to persistent inflation. This persistent inflation is driven by continued additions to the money supply and input costs (diesel, commodities), not by demand for interest rate-sensitive consumer items – that demand has already dissipated to a low level, yet we are still at 3.5%-4%.
You mentioned unspent government funding as a significant inflationary factor. Could you elaborate on this?
The problem we see is the huge inflationary fuel of unspent government funding, paid for by printing money, which higher interest rates do not affect. Money supply has increased 36% since March of 2020, from $15.9 trillion to $20.9 trillion, and will continue to rise if government spending happens as planned. The bulk of over $5 trillion in authorized spending has yet to be spent, and every dollar of that spending will need to be printed with the federal government running deficits in excess of $1.5 trillion.
Isn’t it ironic that one of the biggest spending bills was called the “inflation reduction act?” Was the spending contributing to inflation worth it?
When the government response to COVID first started in 2Q 2020, the first stimulus made sense as it aimed to provide those out of work with the ability to pay their rent, mortgages, car payments, etc. while they waited to go back to work. However, this idea became problematic as too many people received stimulus checks, not just the 10 million newly unemployed, and many of them didn’t actually need the stimulus. Moreover, many were told they did not have to pay their student loans or rent for the foreseeable future. These spending decisions exacerbated the problem and supercharged inflation.
What effect do you think continued high interest rates will have on the housing and apartment markets, and are there any patterns with REITs or other real estate investments in response to inflation?
Our view is that the housing market will remain muted with higher rates, which will keep demand for rental housing steady as long as employment remains solid. We have seen slim numbers when it comes to apartment transactions, with those getting done (including recent deals we have closed) being all cash or low levels of leverage. The need for large equity slugs to purchase has limited the number of buyers. Many who don’t need to sell and who may have high basis seem to be waiting for a more attractive financing market to lure buyers back in. Occupancy and rate growth in our markets are good, despite headline overall U.S. numbers that may include disaster markets like San Francisco and Chicago. Most of our competition in our markets, whether public REITs or others, have been continuing to raise rents to the extent they can’t keep up with rising costs – many of the costs of insurance, energy, payroll have well exceeded the ability to raise rents, unfortunately.
What is your perspective on “outside investors” buying real estate for rental or rehab and resale, and where do you see this trend going in the 1st and 2nd quarter next year?
While it is true that many new home sales have been to large companies in the single-family-for-rent (SFFR) business, it feels like a product of the deal dynamics described above – builders have been building very steadily and find themselves with growing inventory due to low individual demand muted by high interest rates. Large, well-capitalized SFFR companies offer bulk sales from builders that allow them to clear inventory, even if at lower (though still profitable) than expected sales prices. SFFR companies are a larger part of the market because they can pay cash, and debt-reliant individuals are a smaller part of the market because interest rates are high due to the government having to raise interest rates to combat inflation, they themselves created and perpetuate with continued fiscal stimulus.
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