Real Estate Has Lost Its Prime Engine

There’s no free lunch. Everything costs something, and most things measure their cost in money. So how does money measure its cost? In interest rates. And as everyone knows, the cost of money is going through the roof.

Mortgage rates are back over 7%. It’s difficult for people to wrap their spreadsheets around the fact that, in the annals of bank lending, the recent 3% level on mortgage rates was a tremendous aberration. Over the past five decades the mortgage rate was rarely lower than 5%. Only in the wake of the 2008 financial crisis did rates dip below 4%.

Going back to the early 80s, mortgage rates reached 18% at their peak. Fortunately, that was an anomaly too—a direct result of Fed Chair Volcker’s campaign to “break the back of inflation.” (He didn’t win any popularity contests in the process.)

However you run the numbers, mortgage rates have been declining since 1982. This great reduction over two-score years led to two of the biggest bubbles in history: real estate and bonds. With the exception of a few truncated pauses, both asset classes rose relentlessly in price—so much so that there was really never any appreciation that the music could ever stop. Even during the housing crisis 15 years ago, a prompt reduction in rates saved the decade.

The massive tailwind that spawned the real estate price tsunami is over. Even if the Fed, as economists expect, will lower the Fed Funds rate back down to 3% in two years, rates will likely never show the same peak-to-trough decline they did over the past decades. Real estate has lost its prime engine—not just in a cyclical sense but also in a secular one.

Well-priced real estate will always be a good investment. After all, you can live in it, touch it, feel it—and use it to hedge against inflation. But if you’re looking to repeat the gains of the glory years (just) past, you might also believe there’s such a thing as a free lunch.