The persistent and abnormally low interest rate environment has increased risks of a destabilizing shock in the commercial real estate sector — complicating policymakers’ efforts to use low rates to achieve the Federal Reserve’s monetary policy goals, according to Federal Reserve Bank of Boston President Eric Rosengren.
Speaking at a conference in Beijing, Rosengren cautioned that “keeping interest rates low for a long time is not without risks,” and that lenders and investors have piled into commercial real estate partly in pursuit of yield. As CRE prices have risen and cap rates have fallen, he expressed concern that “investors may be engaged in excessive risk-taking.”
While Rosengren said CRE is unlikely by itself to trigger financial instability, “should prevailing economic conditions change in response to a large negative economic shock, commercial real estate prices could decline relatively quickly, leading to large losses at leveraged firms,” he explained. “Because commercial real estate debt is widely held by depository institutions, this could cause a contraction of credit.”
And since the U.S. economy is close to the Fed’s “dual mandate” targets on inflation and employment, “very low rates may cause the economy to attain and exceed sustainable employment, risking greater imbalances that could negatively impact the economy in the future,” Rosengren warned. “And this may be an unfavorable tradeoff.”
