In June, the Federal Reserve held short-term interest rates steady and officials lowered projections of how much they’ll raise them in the coming years. At the same time Britain voted to exit the European Union (BREXIT).
Regarding the Federal Reserve’s decision, it was reacting to rather than leading the market, and now strongly suggests to the market that it has no real vision or strategy. Although it has recently hinted at potentially making a move this year, by not making a move mid-year, The Fed is becoming less credible. At the same time, the market is downplaying the impact of BREXIT. This move sends a strong message of change – that we are now moving away from globalization toward nationalization, something that is also being discussed within our own political system. People are questioning whether the technological and trade advances of the past two-plus decades have delivered on the promised benefits of globalization and free trade.
While other countries could follow BREXIT, it will take some time before we all understand what this means politically and economically. We are making history, not repeating it.
So what does this mean for investors?
Hopefully what it does not mean is negative interest rates as some Asian and European nations are now experiencing. But, if stimulus is thought to be necessary, I think we could see another round of “quantitative easing” before we would consider negative rates. Right now, with no action from the Federal Reserve, we have simply kicked the can down the road and the more we continue to flood the markets with cheap money, the more significant the ultimate correction will be.
There is a tremendous amount of capital looking for yield in this low interest rate environment, causing investors to stretch their risk tolerance. I believe this factor is a significant contributor to an overvalued stock market that continues to hit new highs, while corporate profits decline, with the trickle down result of an 11% decline in corporate tax revenue for the first half of 2016.
The good news is that all of this bodes well for real estate as an investment option. In relative terms it is now less risky than many other assets and can provide long term stable yield. Consider a net lease investment with credit tenancies and long term leases. While the yield may be conservative by pre-recessionary standards, in our “new normal,” both the yield and the security are more attractive. With the low interest rate environment, in most cases, you achieve good positive leverage.
Moreover, what was once considered a low cap rate of 4% to 5% now looks attractive. In addition to cash flow, you have the multiple tax benefits associated with real estate and you are gaining a physical asset with residual value.
Looking ahead, I think that while we are still likely heading toward a market correction, that won’t happen as soon as I had previously thought, much due to the Fed’s decisions not to raise rates in June and BREXIT. It is likely more of a mid- to late -2017 occurrence. However, the longer it takes to get to a correction, the deeper the correction will be.
In this new normal of low-to-negative rates, real estate will continue to provide an excellent diversification strategy, and now is a good time to consider increasing real estate exposure if your long term investment strategy aligns with that option…as Bill Gross and Jeffrey Gundlach said recently, go to commodities: gold, silver and real estate.