The end of easy money

As the European Central Bank prepares to wind down its quantitative easing programme, Meghan Morris examines how global monetary stimulus has affected real estate and what the latest development means for the asset class

The clean-up of the global financial crisis has turned a once-esoteric expression – previously familiar just to those with close knowledge of Japanese monetary policy – into a financial buzzword.

Quantitative easing, in which central banks buy large amounts of assets to stimulate markets, helped the Japanese to fight domestic deflation in the early 2000s. More importantly for global real estate investment managers, the programmes implemented by central banks in the wake of the GFC catalysed investors’ interest in real estate, facilitating record flows of capital and stabilising the asset class.

Kalyan: stimulus buoyed markets

“I would go so far as to say it was the single most important factor in real estate capital markets for decades. It was arguably the most successful economic policy since the Marshall Plan,” Sabina Kalyan, the global co-head of research for CBRE Global Investors, says.

Now, strong recoveries across many economies have led some central banks to wind down their asset-buying programmes. The US started tapering its purchases in 2014, while the UK began last year.

The European Central Bank did not kick off its quantitative easing programme until March 2015, and today, it is following its peers by entering wind-down mode. In June, ECB president Mario Draghi said monthly asset purchases of €30 billion will continue through September and will be cut to €15 billion for October through December, terminating the programme at year-end.

Industry observers say the June announcement did not spook financial markets, including real estate, because it was long expected. As the ECB concludes one of its biggest market interventions, the short history of worldwide financial stimulus offers clues about how real estate in Europe and elsewhere will be affected by the end of quantitative easing in the European Union.

Defining event

Two months after the US introduced quantitative easing, then-Federal Reserve chairman Ben Bernanke highlighted the need for the untested monetary policy in a London School of Economics lecture. His host country would begin its own programme two months later.

“The global economy will recover, but the timing and strength of the recovery are highly uncertain,” Bernanke said in the 2009 speech. “Government policy responses around the world will be critical determinants of the speed and vigour of the recovery.”

Bernanke’s central bank was “the most aggressive and fast-moving when it came to unregular monetary policy in 2008-09,” says Michael Keogh, TH Real Estate’s research director. The Fed’s first of three rounds of quantitative easing saw it purchase $1.25 trillion in mortgage bonds, $200 billion of debt issued by government-backed lenders Fannie Mae and Freddie Mac and $300 billion of long-term Treasury securities.

“Their aggressive approach was one that led the US economy to rebound far swifter than any other global region, stimulating a lengthy upturn in real estate market performance,” Keogh says.

With the Fed leading the way, major central banks began versions of the program, which focused on making government bonds so low-yielding that financial market participants moved up the risk curve.

“We saw capital flows coming into our industry that were absolutely the result of institutional investors saying, ‘We can’t get yields from bonds,’” CBRE’s Kalyan says. In 2009-13, for example, she says investors were buying real estate as a fixed-income substitute, focusing on properties with long-term leases to high-quality corporate tenants – “the real estate that looks most like a bond.”

When the economy began to recover in 2013-14, investors again began buying real estate “that looks more like an equity with decent value-add.”

“There is genuinely a lot of intellectual debate about how much quantitative easing affected the economy,” Kalyan says. “How far did those lower debt yields result in lower costs being passed onto consumers and consumers spending more?” While that was the intent of quantitative easing, another impact emerged that was critical to real estate’s recovery, she says. Companies became more confident that central banks would keep countries out of another recession, so they resumed spending and hiring.

“It’s hard to argue the counterfactual. I strongly suspect we might have entered a Japanese-style deflationary bust” without quantitative easing, Kalyan says.

Keogh echoes these positive views of quantitative easing and its market effects, citing low long-term borrowing rates post-stimulus as one driver of capital into real estate. “This is the defining event of this generation – the whole reason that real estate and all real assets have performed so well,” he says. “It’s unprecedented.”

However, not all industry observers agree about the effect of financial stimulus on real estate.

“The impact of quantitative easing on the actual cost of capital and in the initial stages of recovery is more limited than is generally believed,” Sam Chandan, the head of New York University’s Schack Institute of Real Estate, says. “When we think about the impact on real estate – what those underlying costs of capital are for risk-free assets… the efficacy of the program was fairly limited.”

He attributes “a significant part” of both the initial recovery in asset pricing, as well as sustained growth post-GFC, to a low cost of capital. However, he questions quantitative easing’s role: “I don’t attribute much of what happened with the cost of capital and other elements to quantitative easing itself.”

Capital sought US investments post-GFC not because of the Fed’s monetary policy, but because the market was perceived as the lowest-risk investment opportunity, Chandan argues. In Europe, he says the story differs because quantitative easing coincided with a period of significant political turmoil.

“Quantitative easing has been important as an offset to many of the sources of that geopolitical instability,” Chandan says. “There have been a lot of challenges in Europe where quantitative easing has been impactful, but it had a fairly limited impact to real estate.”

You can’t hide

No matter the specific effects on real estate, the era of easy money is coming to an end for Europe. “Now we are at a moment in time when the economic fundamentals look good, so it’s also the right time to think about how to wean the world off cheap money,” says Marleen Bosma, the head of global research for Bouwinvest Real Estate Investors, which invests on behalf of Dutch pensions. “The most enormous amount of money in history has been pumped into the global economy, but I don’t believe the termination of quantitative easing as such is the issue; it is the pace at which monetary taps are turned off that is critical.”

If the ECB limits its shift in monetary policy to a gradual winding down of its asset-buying programme, for example, the time needed for debt levels to return to what was previously considered healthy will be elongated. However, if the ECB were to both withdraw stimulus quickly and raise interest rates sharply – against current market expectations and its own signals – capital markets could see volatility.

“We believe the effect of quantitative easing is a global phenomenon, so if you want to invest, you can’t hide from it or not be affected by it,” Bosma adds.

She looks to the US as precedent for how European markets may react this year and next: both central banks communicated upcoming monetary policy shifts well, which in the US led to no real effect on commercial real estate valuations.

Longer-term, Bosma says that if yields on government bonds rise, capital flows to real estate may decrease because of the denominator effect. However, rising interest rates could lead to more tactical switches into real estate as pension funds and other investors seek a safe haven for capital. She also notes the increase in borrowing costs would reduce leverage in deals.

For CBRE Global Investors’ Kalyan, the wind-down of quantitative easing has made modeling more difficult than ever. While the ECB’s June announcement was “exactly what we thought,” she says real estate’s econometric models, which assume a reversion to means, must be re-engineered because bond yields will not normalise to 6 or 7 percent.

“Quantitative easing affects everything we do, from the macro, top-level discussions we have with clients to the specific asset underwriting,” she says.

Real estate has spent the better part of a decade operating under historically low interest rates. Knowing such conditions must come to an end, private real estate investment managers are factoring in rate rises and other monetary policy changes to their forecasts.

Certainly, the reducing of government economic stimulus will carry an impact the asset class must engage. But if it, and the wider economy, cannot function under well-telegraphed ECB monetary policy shifts, there are larger concerns ahead.

 

BALLOONING BALANCE SHEETS

The US Federal Reserve made the earliest stimulus moves post-global financial crisis. Its three rounds of asset purchases took place starting in November 2008, November 2010 and September 2012. The agency purchased treasury bonds and mortgage-backed and US agency securities, expanding its balance sheet fivefold, to $4.473 trillion, between 2007 and 2017. The Fed began tapering in 2014, taking the cap approach to unwinding its balance sheet, which sees it progressively stopping reinvestments when assets mature, rather than selling bonds.

The Bank of England quickly followed the US in introducing a stimulus program in March 2009. Its asset purchases focused on UK government bonds; as of mid-July, the bank had £435 million ($568 million; €488 million) of gilts. In a March speech, an economist who sat on the Bank’s monetary policy committee during the GFC said he doubts quantitative easing will be unwound, particularly in the UK, calling the larger balance sheet ‘the new normal.’

The Bank of Japan, which originated the monetary policy concept to kickstart growth in 2001, purchased mainly government bonds and securities starting in April 2013. By December 2016, it had a balance sheet that was 88 percent of the country’s GDP, significantly higher than other central banks’ ratios, according to a Fed paper. The BOJ has been the most private of the central banks, giving fewer signals about its plans than its peers. However, in January, its own taper chatter began when the bank trimmed its government bond purchases.

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