Archive for June, 2008

Explaining long term interest rate increases

Wednesday, June 18th, 2008

Question: Why the uptick in interest rates. I would think with the Fed rate as low as it is, that 30 Year fixed rates would be around 4-4.5%. I see this morning it is around 6.3%.

Answer 1: Short-term interest rates, such as the Fed Funds rate, are rates charged for loans of a year or two or less. Home mortgages, on the other hand, are typically 15-30 year loans, although on average they are paid or refinanced in 8-10 years.

Over the course of ten years the cumulative impact of inflation will be much greater than it will be over just one year. Think about it: if you as a lender are receiving a fixed payment of say $500/month, how much less will that $500 buy you ten years from now than it will today?

You, I and the markets are seeing evidence of increasing inflation every day. It was reported by the government today that wholesale costs for producers and manufacturers increased over 7% over the prior twelve months. That’s signficant.

So when inflation is rising, longer term interest rates rise in tandem to compensate lenders for the risk that inflation will make the future payments they receive worth less.
Several things are going on.

Answer 2: First, mortgages are priced off of the 10-year Treasury, which is yielding 4.25%, while short-term rates are set in comparison with Fed Funds, which is 2.00%.

Second, 10-year Treasury yields have moved up as investors became more worried about inflation, and stopped expecting the Fed to keep lowering short-term rates. The 10-year Treasury yield bottomed out at around 3.30% in March, so it is up nearly 100 basis points.

Third, banks aren’t all that willing to lend, as they work on fixing their balance sheets. Meanwhile, investors in agency debt and mortgage-backed securities, which help set the interest rate on conforming loans, are requiring more of a risk premium over Treasury yields than they did before the credit “bubble” started to collapse last year.

Finally, while the slope of the Treasury curve has flattened recently, it is still a lot steeper than it was last year in the midst of the credit bubble. In other words, investors are demanding a lot higher yield on long-term debt relative to short-term debt than they did a year ago.

Steve Hoyt article on commercial real estate investing

Wednesday, June 18th, 2008

Here’s an article on Steve Hoyt, a successful investor in commercial real estate. On the one hand they say you can make good money hitting singles (as opposed to homers) but on the other hand they call the guy an artist:

What I realized quickly was that Steve had the entire discipline related to real estate that I someday wanted to have,” Lund said. “I do think the art of the deal is something unique. You can’t learn that in college. I think most of Steve’s peers would call him an artist when it comes to real estate.

I don’t think an individual investor needs to be an artist to do OK in real estate. As long as you can hit a few singles before your first strike out….