Daniel Calano, Prospectus, LLC

Who in their right mind would put money into a money market fund, not expect a return on it, and in fact pay the bank money to keep it there? Apparently, quite a few people, including those from Sweden, Denmark, Switzerland, Japan and yes, even contemplated by the Federal Reserve Bank of the United States. How are negative rates actually possible? Regional banks, commercial banks and generally smaller banks are required to keep a certain percentage of funds in a central bank like the Federal Reserve in order to maintain minimum reserve requirements, i.e. a percentage of customer deposits the banks can’t lend out. The central bank normally pays interest on those holdings. Negative interest rates at the central bank mean that the depositor banks would have to pay fees to the central bank, instead of the opposite.

Why would Japanese and European central banks do this, and our Fed consider it? Simply put, they are worried about deflation and want to further stimulate the economy. According to the World Bank, regional commercial banks have been hoarding money instead of lending it, both because of risk aversion and the perception that there are few good opportunities to lend upon. As a result, there is less investment capital in circulation than is optimal. Central banks hope to incentivize regional banks to lend money instead of storing money, thus spurring economic growth.

Unfortunately, there can be unintended consequences. Foremost is that regional banks pass on their new cost to local depositors, who in turn simply pull money out of the bank rather than paying a fee, essentially causing a potential run on the bank, and certainly some panic. Related to this, the general public may perceive this as a last desperate effort by the Fed to stimulate the economy and thus that the economy is in trouble. As a result, individuals further save rather than spend. It is also similar to the current oxymoron of not buying gas despite falling oil prices. While people save money at the gas pump, a good thing, they perceive falling prices as a negative omen. According to Greg McBride, chief financial analyst at Bankrate.com, “The real concern about negative interest rates isn’t going to be the rates themselves. It is going to be the economic conditions that brought it about.” There is also the obvious downside of negative rates impacting IRAs, Keoghs, pension funds, etc., receiving less return than thought possible.

What does this mean to investors/developers in our real estate profession? Even if Yellen were to push interest rates below zero at the Federal Reserve Bank, it seems completely improbable that regional banks would loan on real estate at a no cost. Banks would however, probably further reduce lending rates from today’s level. Unlike typical consumers, who might hoard money because they fear the perceived downturn, real estate professionals would most likely take full advantage of lower rates to purchase more real estate assets. Individuals, who have not previously invested in real estate, may perceive it as the only tangible asset to put money. They could increase the potential pool by changing savers to seeking income producing and potentially appreciating assets, thus pushing demand and prices higher, in that unnatural environment. Also, in seeking yield, regional banks themselves have invested in real estate, according to an analyst at Credit Suisse. Dare we use the bubble word?

Other asset classes, perceived to be able to appreciate, include such things as art, antique cars, equities and gold, all on an upward trend. Japan for example, had been deflationary for some time, instituted negative interest rates years ago, and Japan’s gold index has increased accordingly. Also in evidence is that average sales of real estate, specifically condominiums in Tokyo have increased significantly over the last decade.

The potential for a bubble is significant since, while demand will push up pricing for real estate based upon lower cost or no cost interest, people who occupy and use real estate may well pull back both in rents and purchases. Thus, zero interest rate policies can spur development, perhaps to the extreme, while occupants may become fewer and further between.

Most believe that Yellen will not go to a zero interest rate policy for the U.S. Based on the majority of research, zero interest rate would be unwise, particularly in our economy. We differ from European countries and Japan in that our economy is stronger and growing, and our GDP is far larger. It does not appear that we are desperate enough to move towards zero interest rates, and it is certainly prudent not to signal desperation through a zero interest rate move.

Daniel Calano, CRE, is the managing partner and principal of Prospectus, LLC, Cambridge, Mass.