Federal Reserve issues warning on US commercial real estate values

The US Federal Reserve has issued a warning regarding the valuation of equities and commercial real estate in the US. Even though stock markets have recovered much of their recent falls there would appear to be deep-rooted concerns about the short to medium term outlook for various US asset classes. The Fed’s “Monetary Policy Report” was presented to Congress on Friday with specific reference to equity and commercial real estate valuations.

When you bear in mind that tax cuts introduced by Donald Trump are expected to increase economic activity it was telling to see the Fed refusing to upgrade US economic growth forecasts. There are a number of reasons why the Fed has refused to join the economic growth gravy train.

US base rates

Over the last couple of years the Fed has been perhaps the only voice in the wilderness warning about US economic growth moving too quickly. We know that further interest rate rises are expected during 2018 and indeed this was confirmed on Friday. The rise in US base rates is likely to be gradual as opposed to large one-off increases but even under this strategy the Fed expects base rates to “stimulate the economy over the next two years”. However, if the Fed believes that for example real estate prices are “heady” then why is the proposed interest rate strategy for the next two years likely to support further investment in the sector?

Stock valuations

There is a distinct correlation between stock markets and property prices and when you consider that price-earnings ratios for US stocks are approaching their all-time highs, excluding the 1990s, perhaps there is reason to be concerned? The US is not alone in benefiting from relatively low interest rates which have created a stream of low cost finance which many people are investing in property and shares. When you bear in mind the yields available on property, and to a lesser extent shares, there is certainly margin to be made even when taking into account finance costs.

What was interesting during the recent stock-market wobble was the fact that an initial sell-off of technology shares was relatively short lived. Technology shares, a number of which will not make a profit for many years to come, are a very strong barometer of underlying investor confidence. Prior to the recent wobble, even the most pessimistic of observers from 2017 were starting to turn positive on the US stock market with hopes that more economic growth strategies will emerge from the White House in the short to medium term. Tax cuts, while controversial, will support the US economy and many believe they will actually lead to further growth in the short to medium term.

Investors hover over the sell button

It is ironic that there are serious concerns about the US economy in the short to medium term even though the US is fast approaching “full employment”. Indeed, the Fed believes the US is already at full employment or indeed above and beyond this level. However, something does not quite stack up.

At this moment in time there is minimal upward pressure on wages despite the fact the economy is growing and the employment market is at or approaching “full employment”. If this was the case, and new employment positions were emerging, then these companies would need to better existing rates to encourage individuals to switch jobs. As in the UK, there is also a growing feeling in the US that as base rates do gradually increase this will place significant pressure on those who perhaps overstretched their finances to buy their dream home when finance was cheap.

There is no suggestion that we are approaching another financial crisis – indeed the Fed believes that banking debt levels are of no concern at the moment. If we look back, six months ago many experts commented that the stock market was moving way ahead of economic growth although the economy does seem to have caught up. Whether investors in equity and real estate are right to have the same confidence for the next six months to a year is debatable.

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