What happens if long bonds don't come down for the next 5-10 years and what are the consequences for RE?
I've spoken to quite a few shops who are considering recaps and are so incredibly confident that rates come down and they can refinance ( some even said this summer). Why is this the assumed? Isn't there a small chance that the fed cuts rates and inflation expectations are higher so long bonds actually go up or stay flat? Can the fed truly start QE with where we're at?
Let's say long bonds increase and we see a 10yr at 5% for the next 5+ years. What would that mean for CRE? Are we going to see an implosion from lenders and operators that have been praying for rate cuts? Additionally, does CRE space stay suppressed in terms of hiring and capital allocation as capital goes to other places with a higher yield?
Based on the highest ranked content on WSO, here are some insights into the potential consequences if long bonds don't come down for the next 5-10 years and the implications for commercial real estate (CRE):
Potential Consequences for CRE:
Increased Borrowing Costs:
Refinancing Challenges:
Impact on Property Values:
Reduced Investment Activity:
Potential for Distress:
Why the Assumption of Rate Cuts?
Possibility of Long Bonds Staying High:
Summary:
For more detailed discussions and insights, you might want to explore related threads on WSO.
Sources: Possible Recession?, QE-squared | The Daily Peel | 12/21/22, The Fed is Killing the Economy!!, Down, Down, Baby | The Daily Peel | 5/9/22, Fed Cuts Rate to Zero and Begins $700B QE Program
Bump. Although this post was from 2 years ago, the 10 year is at 5% as of this week. I'm wondering if we're in a structural, long-term environment where long bonds slowly go up over the next few decades just like they slowly came down (with some ups and downs in between of course) from roughly 1980-2020. What do things look like in this industry over the long term in that case? And separately, what would bring long bonds down? Even if we ended the war in Iran today, it feels like federal deficit spending and the resulting increase in US national debt are factoring more and more into long bonds and I don't see that changing anytime soon at all. I also think large buyers of US debt are going to slowly decrease their purchases over time, thereby driving up long bond rates. Thoughts?
Fiscal policy is the only solution or inflating away the debt. We are going to see a return to more traditional equity/debt ratios for transactions. How long for those transactions to be available at appropriate spreads and positive leverage? No idea. People tend to forget this is an alternative asset class, highly illiquid. It boomed because equity could not go get liquid yield from the bond market for 15+ years.
Equity allocations to CRE are going to shrink. Basic portfolio theory. As people are forced to transact, new base lines will keep getting set.
Funds got used to relying on heavy leverage, the players that can raise equity and look at 50%-65% leverage debt will through cash returns and some upside generate 12%+ IRRs. Even the guys that were making money in 2017-2019 selling stuff for 40%+ IRRs originally underwrote 12% returns. I worked at firms that have been around since the 80s, and was able to see how use of leverage evolved over the last 40 years.
The choice is 'look at interest rates, decide to take no risk, do nothing, be out of work' or 'look at interest rates, decide to do something, even if requires real risk-taking, put out fires for years, keep head above water, keep your job' .... ie survive to [insert year manna descends from heaven]
The short answer is that it will be very bad since the biggest asset classes (industrial and multifamily) are priced at unlevered yields that don't make sense relative to current rates (let alone higher rates for a long period of time). Maybe industrial can generate enough NOI growth to stay afloat in that scenario, but multifamily will be in for a rough ride.
Thank you for this comment. Just curious - why do you say that industrial might be able to generate enough NOI growth but not MF? I don't have any industrial experience but my guess is that the unlevered yield in industrial is higher than MF, so it is at least closer to making sense relative to current rates than MF?
Multifamily demand is much more closely tied to population growth which is already plateauing and will decline for its core demographic (22-32 YOs) beginning in the late 2020s to early 2030s. The only thing that might save multifamily demand is that the rent vs buy discount that currently exists could persist for many years.
Industrial demand is more multifaceted.
Interesting, thank you for the comments everyone. Coming from the MF development world, what scares me if we have higher rates for longer is that it will just continue to be extremely difficult to add meaningful housing supply. I guess at some point in the future rents will have to have risen high enough for some projects to pencil again on the margins. But who knows when that will be. It is scary to think about affordability for the coming generation(s)...
As has been pointed out in posts just on this thread, and something I’ve opined on elsewhere - future generations are smaller and will get progressively smaller. Demand will simply not exist to the same degree it did previously. 2020-2022 was the peak for our lifetime.
I work in MF, and it sucks, but that is not conjecture. It is math.
So, I would argue that affordability will not be a concern as we move through the next few decades.
Want to see the future for secondary and tertiary markets? Look at Japan. Best bet is core/“super” core.
That's only true for national aggregate demand though, when you start looking at specific markets there are other factors beyond basic birth/death rates. Continued urbanization, intercity movement, household creations, zoning loosening, etc. all impact what any given market's pricing is. There are cities where demand will not drop just because the population goes down 5%, it's not going to be a uniform decline.
Cities like Los Angeles, New York, Boston, Dallas, etc. are going to remain strong. As the population declines people will continue to hollow out the rural and small towns they've been abandoning for the last 40 years, it will be a lopsided demand shift.
My hope, although I have zero proof, is this last bump in rates will finally lead to capitulation and the basis reset.
I agree with the true basis reset. Not this extend and pretend been going on since 2022
not an expert here by any means but I'd think that making attractive returns as a developer will be hard leading to lower supply leading to higher rental growth down the line. From an investors pov the deals can pencil in to core/core+ returns with income providing most returns vs levered capital gains.
There will be a super difficult transition period of transacting the assets from low rate buyers who will have to take a loss to the new high rate environment buyers. Sellers will be from those with broken capital stacks/lack of debt options.
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