A few weeks ago a 50-metre wide meteorite named 2012 DA 14 passed a mere 17,000 miles from Earth. We can be grateful that this wandering space traveler came to pass, and didn’t come to stay. But a few days later the much smaller Cherbakul Meteorite did collide with the Ural Mountains, injuring an estimated 1,200 people.
The Earth, astronomers observe, is in a bad neighbourhood from the meteorite perspective. But at least we can expect some advance notice of a major collision. It’s instructive to contemplate the impact on real estate of, say, a two-week warning that civilisation was about to be obliterated.
A buyers’ market would emerge. Values and leasing activity would fall. Spending on some discretionary items – hotels, casinos, for example – would rise sharply, as would overtime rates for waiters and croupiers. Other discretionary retail outlets – furniture stores, health clubs, for example, would stand empty. Some service providers such as dentists would suffer mass cancellations. Online retailers might experience a short-lived boom. And, with a spike in credit card use, interest rates would rise: but who would care?
So, why is this relevant? Because right now official interest rates in many economies are at, or close to, zero. Bond yields are near multi-decade lows. It’s the meteorite thought experiment in reverse. Low interest rates have many, and sometimes unexpected, impacts on real estate.
Low interest rates imply low investment hurdle rates and long pay-back periods. It is precisely these trends that monetary authorities hope will tempt companies and households back into investment and spending mode.
Sustainability is a front-line topic right now, and low interest rates favour the environmental argument. Low interest rates encourage construction, which is energy intensive. But, by extending payback periods, the type of construction is also altered. Longer payback periods support investment in structures with longer life cycles. One reason why the 1970s is now widely regarded as a decade of poor design is because it was also a decade of high interest rates.
But not all construction is encouraged. Option prices also fall along with interest rates. So owners of vacant land are in no hurry to get into development mode – the opportunity cost of waiting is low. But many existing buildings, designed for a higher interest rate economy, will now seem under-specified. So look for a cycle of refurbishment and upgrading of existing assets.
Low interest rates also have locational impacts if they are regarded as permanent. Mining companies adjust, where they can, to exploiting lower grades of ore or reducing the rate of extraction, therefore extending mine lives. Exploration is encouraged. So investment in infrastructure, houses and shops in mining communities becomes more viable.
Low interest rates encourage investment in human as well as physical capital. More years of study increases demand for student accommodation. But it takes longer for workers to build up retirement savings. So people enter the work force later, and leave it later. Demand for retirement accommodation may be postponed.
The impact of today’s low interest rates is complex, diverse and likely to be with us for a long time. But be warned: at any time 2013 DA 15 could emerge from the cosmos and throw all these trends into reverse.
