The Implications of a Falling Euro

 

The European Central Bank is the central bank for Europe’s single currency, the “euro”. The euro was first used in 1999 at which time there were 11 member nations in the European Union. Today, there are 16 countries which are members.

The credit crisis we have experienced in the U.S. was not isolated. Counties all over the globe have been affected and, most recently, the so-called PIIGS nations have been suffering significantly. Economies in Portugal, Italy, Ireland, Greece and Spain have seen debt to GDP ratios explode and needed austerity measures have already prompted both strikes and riots, most notably, in Greece. All of the uncertainty surrounding many of the EU economies has exerted substantial downward pressure on the euro.

Last Friday, the euro closed at 1.2381 to the dollar, its lowest level since April of 2006. So, what are the implications for the commercial real estate sales market of a euro at this level?

Many participants in the market felt that the strength of the euro (or conversely the weak U.S. dollar) was the main reason for the increase of foreign investment in the U.S., and particularly New York and Washington D.C., markets in 2008. From February 2008 through the end of the year, the euro was hovering slightly above or slightly below $1.50. During this period, we saw a tangible increase in the number of foreign high-net-worth investors looking to purchase investment properties in New York, which has continued since. Those who thought that the strong euro was the reason for increase foreign demand have speculated that the falling euro would cause a reduction in the amount of foreign demand. We do not, however, believe that the weak U.S. dollar was the primary stimulus for this foreign interest and that this factor is highly overemphasized as the reason for foreign demand.  

Consider the following: If a foreign investor is purchasing an investment property in the U.S. because the dollar is weak relative to their currency, they are receiving gross rents in the weak currency, they received net operating income and cash flow in the same weak currency and, if they choose to sell the property, they receive their profit in the same weak currency. Therefore, the only way the weak U.S. dollar creates an incentive to invest here is if the foreign investor is utilizing a currency arbitrage strategy whereby they believe the value of the U.S. dollar will increase at a greater rate than their own currency over the holding period.

We believe that foreign investment in the U.S. is much more a function of the relative economic and political stability that the U.S. offers. The present uncertainty oversees is driving investment capital into America in quantities not seen since the mid-1980s. We have closed numerous transactions with foreign investors recently with many more looking to deploy capital here. The number of foreign investors looking to purchase real estate is simply staggering and adds to the overwhelming demand that exists today.

Perhaps the most impactful implication of the falling euro is its impact on interest rates. This is significant as rising interest rates are one of the biggest downside risks the market is looking at.

When the fed ended its asset buying program at the end of March, it exerted upward pressure on interest rates. We saw the 10-year treasury rise from about 3.5% to over 4%. About 3 weeks ago, the fed announced that it would begin a program to sell its $1.3 trillion of assets over time. This method of exiting the market would also serve to exert upward pressure on interest rates. However, with all of the debt problems and uncertainty in global economies, and particularly in Europe (as illustrated by the falling euro), there has been a flight to quality and safety which means a flight to U.S. treasuries. Given the overwhelming demand for treasuries, we saw the 10-year close at 3.44% on Friday.

These lower rates have positive implications for our real estate market. When interest rates stay low, commercial mortgage lending rates stay low as well. This is a necessary and important factor for the health of the investment sales market. We still have a massive amount of deleveraging to deal with and low mortgage rates make dealing with deleveraging that much easier. Additionally, to the extent rates rise significantly, it will create even more negative equity and distress in the market as values fall based upon higher borrowing rates.

The falling euro has, therefore, had a beneficial impact on our market, not directly but indirectly. The causes of the euro’s fall have created a flight to quality and safety which has kept interest rates down and the falling euro has not eliminated any of the foreign purchasing demand from the marketplace.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty services in New York City and has brokered the sale of over 1,050 properties in his career having a market value in excess of $6.2 billion.

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4 Responses to “The Implications of a Falling Euro”


  1. 1 UrbanDigs May 25, 2010 at 8:47 am

    Aha, very interesting take and I certainly agree with your statement: “they are receiving gross rents in the weak currency, they received net operating income and cash flow in the same weak currency and, if they choose to sell the property, they receive their profit in the same weak currency. Therefore, the only way the weak U.S. dollar creates an incentive to invest here is if the foreign investor is utilizing a currency arbitrage strategy whereby they believe the value of the U.S. dollar will increase at a greater rate than their own currency over the holding period.”

    However, like interpretations of data, there can be two other angles one can interpret as the forces that drive the Euro lower, may impact our market. I see this as:

    1. Decline in Purchasing Power – for high net worth individuals, their euros buy significantly LESS HOUSE for the same amount they would have spent otherwise. This to me is psychologically signifcant as I always have taken a psychological/confidence angle for our markets. Its all about the buyers and the bids for residential, its all about the cash flow/cap rates/grm for investors.

    2. Confidence – sure rates are declining, but that is as a result of such negative forces that is causing a negative wealth effect for portfolios around the globe and a shock to confidence to the buyers/investors looking to put money to work. The result is a less liquid marketplace. Its too soon to tell right now how this plays out (recall that the major adjustment we had in our markets was 1 yr AFTER the credit crisis began), but my eyes are open. Lower rates seems to be the only spin brokers can put to support a bullish argument. But in my view, that argument always is around the BIDS. And to me, confidence, wealth effect and liquidity are greater forces affecting bids right now then lower financing costs.

    Just my two cents. As always, great article!


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