Interest Rates Are bonds the next bubble to burst? Many financial analysts believe they are. If so, this is something that could blindside your world and your business. Let me explain. Whenever we pat ourselves on the back for getting that fantastically low rate on financing for a project or a mortgage we should recognize that we are essentially taking advantage of the low side of a teeter totter. When the demand for bonds drives the price of bonds higher and higher, this drives interest rates lower and lower. Real estate has enjoyed the long term decline of interest rates since the early 1980’s. But what if this trend was to reverse and interest rates start to head back up again? Remember that from an institutional investment perspective, pension funds and other large endowments view real estate as a substitute for bonds. But all else being equal, investors would prefer the security of bonds.
So if - and when - bond prices come down (on a relative basis), bonds become more attractive; this draws money from the real estate arena. In essence, investors take on a bit more risk in order to increase the yield of their portfolio. However, when there is an opportunity to reduce that risk and lock in a better rate on bonds, money will flow from real estate into bonds. Thus the tag of “Interest Rate Sensitive” for the real estate sector. We need to be reminded that we are in a historically low interest rate environment; one that is unprecedented. As Andrew Mystic notes in his article Bondage: Handcuffed to Lower Rates in Q2/12, “Taking a longer perspective, it’s difficult to argue that rates have not come to the end of their bullish 30-year secular trend. For this reason we remain somewhat bearish on bonds.” (http://www.stevebaird.ca/media/ documents/BairdGroupIPQQ22012. pdf.)
Why is this important to you as an architect? My thesis is that rising interest rates may create a headwind for the developments and projects you are working on. In essence, higher rates create higher costs for the developers but during construction as well as for the owners after construction. Interest costs are very important component in the overall profitability and feasibility of a project. In a perfect world, interest rates would remain low and stable in the future. Along with a stable global credit market this would create the perfect environment for projects and the business of architecture. The risk comes in the form of interest rate spikes and any other unforeseen sudden changes. In summary, we live in a global village. International economic storms have the potential to derail the economic backdrop that allows the B.C’s architectural landscape to thrive. By keeping an eye on the key areas indicated here, hopefully we can all make better - and more successful business decisions.
We talk about low yields, but how low are we...? The Baird Group is based in Vancouver, British Columbia. The group’s mission is to empower investors by breaking away from the frustration of traditional investing. For more information, go to: http://www.stevebaird.ca/.
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