Renowned market commentator James Grant, founder and editor of Grant’s Interest Rate Observer, and Green Street’s Michael Knott discuss the economy, financial markets, and commercial real estate

Source: Grant’s Interest Rate Observer

Michael Knott, Managing Director with 15 years tenure at Green Street, recently hosted a conference call with James Grant, a financial historian, author, and market commentator. Green Street takes pride in covering macro trends that have implications for commercial real estate, and Grant offers a complementary perspective on the broader financial markets and overall economy. Knott began the conversation by asking Grant for his general thoughts on today’s interest rates, and later, they discussed real estate, gold and the state of China’s economy.

Interest rates

Grant kicked off his commentary with the morning news (from June 14, 2017) that the Federal Reserve opted to raise interest rates by 25 basis points, a move that he sees as likely to be the last hike of the year. With such low rates, Grant sees the values as “nearly invisible to the naked eye.” He noted with rates so low, central banks have limited flexibility to decrease them if needed.

Grant’s primary concern relates to the artificial nature of these rates. Given that interest rates are the most important “price” in a capitalist system, their artificial nature vaults investors into what Grant referred to as a “hall of mirrors.” He believes markets are merely as efficient as the people who operate in them, and that fake perceptions caused by artificially-determined interest rates distort investment decisions.

Deadening debt

The conversation then turned to the Fed’s massive $4.5 trillion balance sheet. Grant said the central bank potentially missed its window to normalize monetary policy in the form of raising interest rates and shrinking its balance sheet, due to what has thus far been the slowest nominal GDP growth among the 15 “tightening” periods in the modern era. “Nothing imminently dramatic will happen with regards to the Fed’s balance sheet,” Grant said. “Foreign central banks have resumed their buying of U.S. Treasuries. Their return could potentially offset Federal Reserve asset sales,” he added.

Chart from Green Street Advisors, Real Estate Analytics: Commercial Property Outlook (May 18, 2017)

In subsequent discussions of the Federal Reserve, Grant became increasingly critical, noting that the central bank is “suppressing the very nature of capitalism” by removing downsides and obsessing over asset values, which limits economic dynamism. Grant does not believe this approach is working. In his eyes, society should have “long ago lost patience with the propositions” of central banks. Moving forward, he sees little sign of central bank or debt “fatigue,” and views China’s massive debt as an accident waiting to happen. Given the nature of fiat currencies, Grant worries about the ability for nations to continually pile up debt, a trend he sees as deadening, not stimulating, economic production.

Gold run?

Moving into gold and commercial real estate, Grant sees pros and cons for real estate as an “inflation hedge” compared to gold, depending on the specific inflationary environment. For instance, if commercial real estate becomes structured in a way that allows property owners a head start on inflation through rental increases, it could fare better than gold. On the other hand, we could see a scenario like the 1970s, in which gold prospers as investors realize they can't recoup lost purchasing power through interest rates. Given President Trump’s penchant for low interest rates, Grant sees a run like gold had in the ‘70s as a possibility.

So….when is the next recession?

At the call’s conclusion, when Grant was asked when he expects the next recession, he humorously declared, “2016, I insist on that.” While Grant elected not to further speculate on the timing, he expects there will be plenty of discussion regarding central banking management and quantitative easing once the recession does begin.

Interest rates and real estate

Green Street has written extensively on the relationship between interest rates and real estate. Michael Knott explains that the effects on cap rates are dependent upon why rates are rising. “If real rates are going up without corresponding inflation expectations, then cap rates would ostensibly need to rise,” he said. On the other hand, “If inflation expectations are moving, but real rates are not, rents and net operating income should move up, helping to offset the upward movement in the discount rate.”

Reminders for the REIT world

Rising interest rates present a risk, but that doesn’t mean it’s time to hide under a rock. Investment strategies based on interest rate predictions are far less likely to pan out than those rooted in a fundamentally sound approach toward stock selection.

Listen to the full replay of this conference call here. To learn more about Green Street’s macro research offerings, visit our website pages on REIT Research and Real Estate Analytics.

Visit the Grant’s Interest Rate Observer website here for additional information about James Grant.