What Is Quantitative Easing—And How Does It Affect the Real Estate Market?

From a macro perspective, Federal Reserve policy and the potential effects of fiscal stimulus are the most important factors in determining the direction of the economy. Their impacts on real estate cannot be overstated.

What is quantitative easing?

When the wise overlords at the Federal Reserve decide to employ quantitative easing (QE), they are essentially deciding to buy financial assets (typically U.S. Treasuries and Mortgage-Backed Securities). They do this in an attempt to spur economic growth by lowering interest rates, encouraging risk-taking, and stabilizing markets.

They do not have to come up with money from somewhere on their balance sheet. They simply create reserves “out of thin air” and swap those reserves for the securities they are purchasing from a bank. The bank had previously been holding an interest-bearing treasury security, and now it’s holding an overnight reserve.

QE at its core is nothing more than an asset swap, where the Fed removes longer-dated, interest-bearing bonds from circulation and replaces them with reserves on the balance sheets of its member banks.

By removing billions or trillions of bonds from circulation and therefore reducing the overall supply, the price of the bonds goes up and the interest rates go down.

Consequences of QE

Manipulating interest rates in this manner has many consequences, some intended and others unintended.

For starters, pushing rates below the prevailing market level sends a signal that borrowed funds are cheap. Interest-rate-sensitive activities are increased throughout the economy to a greater extent than would be the case in a free market. Both owner-occupied and investment real estate markets get distorted as a result. The housing boom and bust of the early and mid 2000s was enabled first and foremost by the easy money policy of the Fed in the aftermath of 9/11.

With lower interest rates, people can borrow money to afford a larger house, a nicer car, better vacations; they can obtain an overall more expensive lifestyle.

In the investing world, people can pay higher prices for income-producing real estate and still generate strong returns due to the low interest rates.

The distortions in the economy created by such policies eventually correct themselves, which usually means a recession as the economy recovers from the misallocation of resources.

Very low interest rates also cause increased speculation and risk-taking in financial markets. When it is impossible to make money in a savings account or by holding treasuries, market participants are forced further out on the risk curve into junk bonds, stocks, and real estate. Much of the speculative frenzy in the stock market today is being driven by the low interest rate policy, which has been causing asset price inflation given the relationship between asset prices and the underlying cash flow of the assets.

Impact on the economy

Spoiler alert: Stimulus doesn’t do a whole heck of a lot of stimulating.

Generally speaking, you can expect one or two quarters of slightly above-trend growth from stimulus, followed by an increasingly sluggish economy thereafter. The main reasons for this are twofold: Debt has a chilling effect on economic growth, and government spending tends to misallocate resources and crowd out the private sector.

As the debt-to-GDP percentage rises, GDP growth tends to fall. There is a diminishing return associated with adding additional debt to the economy. With debt-to-GDP at record levels, additional debt incurred through new stimulus will hurt the economy in the long term after an expected transitory bounce.

The past 12 years or so have been characterized by QE and various deficit spending or tax cut “stimuli” that have resulted in small boosts to GDP growth, but overall growth has trailed prior expansions. Consider the transitory boost from the 2009 stimulus, which resulted in Q3 2010 GDP growth of roughly 3.18% and quickly fell below 1% by Q3 of 2011.

Similarly, tax cuts and large fiscal spending budget deficits created a small transitory bump that pushed Q3 2018 GDP growth over 3.3%, only to see growth wane again through 2019.

Compare that with GDP growth in the 80s and 90s, when quarterly growth rates were very often well into the 3% and 4% range or better.

What QE means for real estate looking forward

Over the next few quarters, I expect to continue to see strong performance in the real estate market as low interest rates and government stimulus prop up the underlying weakness in the economy. Rents will continue to be paid and the government will maintain a “whatever it takes” sort of attitude.

However, the piper must be paid. Borrowing money simply means pulling future economic activity forward, which needs to be paid back with interest. New jobless claims are still abysmal and there may well be another shoe to drop when banks start requiring borrowers to pay back deferred loan amounts.

It’s important to remember that the employment picture is still ugly. Initial unemployment claims bottomed at 711,000 and have been on the rise again, with the latest weekly reading at time of writing at 847,000 people filing for initial unemployment. For context, that low point of 711,000 is higher than any point in history before the COVID-19 recession. That’s 10 consecutive months where initial jobless claims have exceeded any point in history prior to March 2020.

While additional stimulus and QE may provide a few more quarters of solid GDP growth and some moderate inflation, I think that we are in for some serious economic weakness in the longer term.

Putting a timeframe on it is extremely difficult, but two to three quarters would line up well with historical precedent, followed by very sluggish growth thereafter. When growth is minimal to begin with, it doesn’t take much to tip into recession. When that happens, given the heavy debt load with no other way out, I expect the government to “cross the Rubicon” and begin to monetize the debt and directly distribute fiat currency to people.

I think we’ll see some very weak GDP prints, more unemployment issues, and a decline in asset prices when this occurs, which will provide a strong buying opportunity for those with the capital and courage to act.

My strategy is to continue to look for solid real estate deals that will perform well under multiple scenarios, while trying to build resources for what I believe will be much better buying opportunities at some point in the intermediate future.

I am looking for assets that do well in an inflationary environment and have a chance to show rent growth that outperforms CPI. To me, this means multifamily in high-growth markets or markets that I think will be in growth mode soon. That means self-storage properties in high traffic areas with low supply ratios. That means manufactured housing communities in areas seeing strong population growth. That means real estate tied to agricultural commodities, which will be in high demand globally for decades.

A continued approach of disciplined underwriting, patience, and long-term fixed-rate debt to acquire good real estate is the best path forward. And maybe sell a couple marginal assets to raise cash for the opportunities that are coming down the road.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.