Low interest rates may be encouraging speculation in commercial real estate reminiscent of the New England bubble in the late 1980s, Eric Rosengren, president of the Federal Reserve Bank of Boston warned Thursday.
Prices for commercial real estate have now spiked above the peaks reached before the last financial crisis and multifamily mortgages have climbed to just shy of their pre-recession peak, Rosengren told the Greater Concord Chamber of Commerce in New Hampshire.
"We care about potentially inflated commercial real estate prices because they might risk a bout of financial instability," Rosengren said. "History shows that most periods of serious financial instability involve a scenario in which debt is high relative to a volatile underlying asset and the value of the asset subsequently declines."
Commercial real estate prices on the East and West coasts are increasing fast. For example, a Seaport tower that is home to accounting giant PwC sold in April for $452 million, the highest price per square foot ever for an office building in Boston. The building was bought by German real estate fund Union Investment.
Real estate experts said they are seeing surging demand for Boston properties from foreign investors, looking for a safer, long-term bet.
But some of that demand may be driven by the low interest rate environment, Rosengren said.
"One potential cost to keeping rates too low for too long is that doing so might encourage excessive risk-taking in commercial real estate — a sector likely to be influenced by low borrowing costs," he said. He added that in New England in the late 1980s and early 1990s, when the bubble burst, borrowers defaulted, lenders were left with half-finished projects and empty towers, and several banks failed.
Interest rates have been at rock bottom since the financial crisis and lenders and investors chasing higher yields have turned to commercial real estate for potentially higher returns. The yield on 10-year Treasuries on Wednesday was 1.73 percent.
The Federal Reserve has also kept its federal funds rate at near zero since 2008 in an attempt to spur employment and business investment. The Fed raised the rate by a quarter point in December and economists expect it to lift it again in the coming months by another quarter point. However, central bankers have been cautious about raising rates too quickly, considering the slower-than-expected economic growth during the beginning of the year.
Rosengren said he expects US economic growth will pick up in the coming months from the 0.5 percent rate last quarter. He pointed to other signs of an improving economy, including improving wages, rebounding auto sales, and a steady growth in jobs.
"If the economic data that come in over the course of this quarter confirm these trends, it will be appropriate to continue the gradual normalization of monetary policy that began with the initial increase of short-term rates last December," Rosengren said.