1. Asset Valuations

Prices of risky assets have risen further on the improved economic outlook, and valuations are generally high

Broad equity market indexes have reached record highs in recent months. Yields on corporate bonds and leveraged loans remain at low levels relative to their historical ranges. Meanwhile, yields on long‐term Treasury securities have risen over the past few months but remain low by historical standards. Reflecting, in part, increased prices, some measures of risk compensation, which account for the still‐low level of interest rates, have decreased to levels that are low relative to their historical norms.

On balance, indicators of commercial real estate (CRE) valuations remain high; however, low transaction volumes—especially for distressed properties—may mask declines in commercial property values. Farmland prices remain elevated relative to rents and incomes. Supported by relatively low mortgage rates, house prices have continued to increase amid strong home sales.

Looking ahead, asset prices may be vulnerable to significant declines should investor risk appetite fall, progress on containing the virus disappoint, or the recovery stall. Some segments of the economy—such as energy, travel, and hospitality—are particularly sensitive to pandemic‐related developments.

Table 1 shows the sizes of the asset markets discussed in this section. The largest asset markets are those for corporate public equities, residential real estate, Treasury securities, and CRE.

Table 1. Size of Selected Asset Markets
Item Outstanding
(billions of dollars)
Growth,
2019:Q2–2020:Q2
(percent)
Average annual growth,
1997–2020:Q2
(percent)
Equities 46,922 22.0 9.2
Residential real estate 41,272 7.4 5.7
Treasury securities 20,946 26.0 8.3
Commercial real estate 20,914 3.9 7.0
Investment‐grade corporate bonds 6,551 9.1 8.5
Farmland 2,569 .9 5.3
High‐yield and unrated corporate bonds 1,652 25.0 7.1
Leveraged loans* 1,193 0 14.4
       
Price growth (real)
Commercial real estate**   7.5 2.8
Residential real estate***   7.7 2.3

Note: The data extend through 2020:Q4. Growth rates are measured from Q4 of the year immediately preceding the period through Q4 of the final year of the period. Equities, real estate, and farmland are at market value; bonds and loans are at book value.

* The amount outstanding shows institutional leveraged loans and generally excludes loan commitments held by banks. For example, lines of credit are generally excluded from this measure. Average annual growth of leveraged loans is from 2000 to 2020:Q4, as this market was fairly small before then.

** One-year growth of commercial real estate prices is from December 2019 to December 2020, and average annual growth is from 1998:Q4 to 2020:Q4. Both growth rates are calculated from value-weighted nominal prices deflated using the consumer price index.

*** One-year growth of residential real estate prices is from December 2019 to December 2020, and average annual growth is from 1997:Q4 to 2020:Q4. Nominal prices are deflated using the consumer price index.

Source: For leveraged loans, S&P Global, Leveraged Commentary & Data; for corporate bonds, Mergent, Inc., Corporate Fixed Income Securities Database; for farmland, Department of Agriculture; for residential real estate price growth, CoreLogic; for commercial real estate price growth, CoStar Group, Inc., CoStar Commercial Repeat Sale Indices; for all other items, Federal Reserve Board, Statistical Release Z.1, "Financial Accounts of the United States."

Treasury yields and term premiums have risen but remain low

Since the previous report, yields on longer‐dated Treasury securities have moved up to their pre‐COVID levels (figure 1‐1). Model estimates of Treasury term premiums have also risen but are still negative, and implied volatility on long‐term interest rates has edged up (figures 1‐2 and 1‐3).3 The increases in yields and term premiums are consistent with market perceptions of an improved economic outlook, higher inflation expectations, and diminished downside risks from the pandemic. Still, Treasury yields remain low relative to their historical range, and an increase in term premiums, if not accompanied by a strengthening of the economic outlook, could put downward pressure on valuations in a variety of markets.

1‐1. Yields on Nominal Treasury Securities
Figure 1‐1. Yields on Nominal Treasury Securities

Accessible Version | Return to text

Note: The 2‐ and 10‐year Treasury rates are the constant‐maturity yields based on the most actively traded securities.

Source: Federal Reserve Board, Statistical Release H.15, "Selected Interest Rates."

1‐2. Term Premium on 10‐Year Nominal Treasury Securities
Figure 1‐2. Term Premium on 10‐Year Nominal Treasury Securities

Accessible Version | Return to text

Note: Term premiums are estimated from a 3‐factor term structure model using Treasury yields and Blue Chip interest rate forecasts.

Source: Department of the Treasury; Wolters Kluwer, Blue Chip Financial Forecasts; Federal Reserve Bank of New York; Federal Reserve Board staff estimates.

1‐3. Implied Volatility of 10‐Year Swap Rate
Figure 1‐3. Implied Volatility of 10‐Year Swap Rate

Accessible Version | Return to text

Note: Implied volatility on 10‐year swap rate, 1 month ahead, derived from swaptions.

Source: Barclays.

Measures of Treasury market functioning have generally been stable since the stresses of spring 2020 receded. However, on February 25, market liquidity deteriorated following a disappointing seven‐year Treasury note auction and an accompanying sharp increase in Treasury yields. Some liquidity metrics, such as market depth, deteriorated significantly (figure 1‐4).4 Market depth overall rebounded in subsequent weeks; however, for short‐ and medium‐dated securities, the recovery was uneven and slower on net. This event highlighted the importance of continued focus on Treasury market resilience. The FSOC recently called for an interagency effort to understand key causes of last year's Treasury market disruptions and to enhance market resilience.

1‐4. Treasury Market Depth
Figure 1‐4. Treasury Market Depth

Accessible Version | Return to text

Note: Market depth is defined as the average top 3 bid and ask quote sizes for on-the-run Treasury securities.

Source: Interdealer broker community.

Corporate bond spreads declined to low levels, while issuance remained solid

Since the November report, amid the increase in Treasury yields, yields on higher‐rated corporate bonds increased modestly, while yields on lower‐rated corporate bonds declined significantly (figure 1‐5). These movements left the spreads of lower‐rated corporate bond yields over comparable‐maturity Treasury yields very narrow relative to their historical distributions (figure 1‐6).5 Corporate bond spreads in sectors heavily affected by the pandemic—such as energy, airline, and hospitality—also declined but remain wider than average spreads across all industries. The excess bond premium, which is a measure that captures the gap between corporate bond spreads and expected credit losses, is at the bottom quintile of its historical distribution, suggesting elevated appetite for risk among investors (figure 1‐7).6

1‐5. Corporate Bond Yields
Figure 1‐5. Corporate Bond Yields

Accessible Version | Return to text

Note: The triple‐B series reflects the effective yield of the ICE Bank of America Merrill Lynch (BofAML) triple‐B U.S. Corporate Index (C0A4), and the high-yield series reflects the effective yield of the ICE BofAML U.S. High Yield Index (H0A0).

Source: ICE Data Indices, LLC, used with permission.

1‐6. Corporate Bond Spreads to Similar‐Maturity Treasury Securities
Figure 1‐6. Corporate Bond Spreads to Similar‐Maturity Treasury
Securities

Accessible Version | Return to text

Note: The triple‐B series reflects the option‐adjusted spread of the ICE Bank of America Merrill Lynch (BofAML) triple‐B U.S. Corporate Index (C0A4), and the high‐yield series reflects the option-adjusted spread of the ICE BofAML U.S. High Yield Index (H0A0).

Source: ICE Data Indices, LLC, used with permission.

1‐7. Excess Bond Premium
Figure 1‐7. Excess Bond Premium

Accessible Version | Return to text

Note: The excess bond premium (EBP) is the residual of a regression of corporate bond spreads on controls for firms' expected defaults. By construction, its historical mean is zero. Positive (negative) EBP values indicate that investors' risk appetite is below (above) its historical mean.

Source: Federal Reserve Board staff calculations based on Lehman Brothers Fixed Income Database (Warga); Intercontinental Exchange, Inc., ICE Data Services; Center for Research in Security Prices, CRSP/Compustat Merged Database, Wharton Research Data Services; S&P Global Market Intelligence, Compustat.

Corporate bond markets appear to have functioned smoothly since the November Financial Stability Report, and bid‐ask spreads remained within historical norms. The Federal Reserve's corporate credit emergency lending facilities, as well as several other facilities, expired at the end of last year and are no longer authorized to purchase eligible assets. This event left no imprint on markets.

Corporate bond issuance by both investment‐ and speculative‐grade firms has remained solid, as companies boosted their cash buffers and refinanced their debt at lower interest rates and longer maturities. The share of investment‐grade issuance with the lowest ratings has increased. However, within speculative‐grade bonds, the share of new bonds with the lowest ratings remained subdued through the first quarter of 2021. While the composition of new issues of investment‐grade bonds has become riskier, overall credit quality of outstanding bonds has improved since November as actual and expected defaults have declined.

Spreads on leveraged loans, in both the primary and secondary markets, have narrowed further since the fall (figure 1‐8). These spreads are now in the bottom quintile of their post‐2008 distributions.

1‐8. Secondary‐Market Spreads of Leveraged Loans
Figure 1‐8. Secondary‐Market Spreads of Leveraged Loans

Accessible Version | Return to text

Note: The data show secondary‐market discounted spreads to maturity. Spreads are the constant spread used to equate discounted loan cash flows to the current market price. B‐rated spreads begin in July 1997.

Source: S&P Global, Leveraged Commentary & Data.

Equity prices increased amid continued high volatility, and valuations continue to be supported in part by low interest rates

Equity prices have increased, on net, since November 2020. Forecasts of corporate earnings have risen roughly in line with equity prices, so the ratio of prices to forecasts of earnings remains near the top of its historical distribution (figure 1‐9). Meanwhile, the difference between the forward earnings‐to‐price ratio and the expected real yield on 10‐year Treasury securities—a rough measure of the compensation that investors require for holding risky stocks known as the equity premium—has declined since November (figure 1‐10). A lower equity premium generally indicates investors have a higher appetite for the risk of investing in equities. However, this measure of the equity premium remains above its historical median, suggesting that equity investor risk appetite, though higher since November by this measure, is still within historical norms. That said, this measure is close to its lowest level over the past 15 years. Option‐implied volatility, a proxy for perceived uncertainty, remains above pre‐pandemic levels (figure 1‐11).

1‐9. Forward Price‐to‐Earnings Ratio of S&P 500 Firms
Figure 1‐9. Forward Price‐to‐Earnings Ratio of S&P 500 Firms

Accessible Version | Return to text

Note: Aggregate forward price‐to‐earnings ratio of S&P 500 firms. Based on expected earnings for 12 months ahead.

Source: Federal Reserve Board staff calculations using Refinitiv (formerly Thomson Reuters), Institutional Brokers Estimate System estimates.

1‐10. Spread of Forward Earnings‐to‐Price Ratio of S&P 500 Firms to Expected 10‐Year Real Treasury Yield
Figure 1‐10. Spread of Forward Earnings‐to‐Price Ratio of S&P
500 Firms to Expected 10‐Year Real Treasury Yield

Accessible Version | Return to text

Note: Aggregate forward earnings-to-price ratio of S&P 500 firms. Based on expected earnings for 12 months ahead. Expected real Treasury yields are calculated from the 10‐year consumer price index inflation forecast and the smoothed nominal yield curve estimated from off-the-run securities.

Source: Federal Reserve Board staff calculations using Refinitiv (formerly Thomson Reuters), Institutional Brokers Estimate System estimates; Department of the Treasury; Federal Reserve Bank of Philadelphia, Survey of Professional Forecasters.

1‐11. S&P 500 Return Volatility
Figure 1‐11. S&P 500 Return Volatility

Accessible Version | Return to text

Note: Realized volatility estimated from 5-minute returns using an exponentially weighted moving average with 75 percent of the weight distributed over the past 20 days.

Source: Bloomberg Finance L.P.

In contrast to the mixed signals from price‐based measures, a number of nonprice measures suggest that investor appetite for equity risk is elevated relative to history. The pace of initial public offerings (IPOs) has increased to levels not seen since the 1990s. In addition, a rising share of IPOs is supported by special purpose acquisition companies (SPACs), which are nonoperating corporations created specifically to issue public equity and subsequently acquire an existing operating company. For a broader discussion of risk appetite, see the box "Vulnerabilities from Asset Valuations, Risk Appetite, and Low Interest Rates."

Vulnerabilities from Asset Valuations, Risk Appetite, and Low Interest Rates

Assessing vulnerabilities from asset valuations is a part of the Federal Reserve's financial stability framework. High asset valuations, relative to the general level of interest rates and the income flows generated by different types of assets, suggest investors require less compensation for the risks they are taking and, thus, have elevated appetite for or willingness to invest in risky assets. At times when risk appetite is elevated, investors may take on excessive leverage or engage in other forms of risk‐taking, which are vulnerabilities that are addressed in other parts of the Federal Reserve's financial stability framework. In addition, should risk appetite decline from elevated levels, a broad range of asset prices could be vulnerable to large and sudden declines, which can lead to broader stress to the financial system.

In this discussion, we first provide a short primer on factors affecting asset prices. Next, we explore methods that are used to assess investor risk appetite, focusing on approaches that account for economic fundamentals. And, finally, motivated by the notable decline in interest rates over recent decades, we ask how persistently low interest rates might affect valuations and risk appetite.

Factors affecting asset prices

People and businesses invest now to receive income in the future. There are various theories explaining asset prices. According to a long‐standing theory, an asset's price should equal the expected discounted value today of future payoffs from holding assets—for example, interest payments from Treasury securities and corporate bonds as well as dividends from stocks.1 Investors also want to be compensated for the relative risk of their investments, so the expected rate of return will tend to be higher for riskier assets such as equities and corporate bonds than for Treasury securities. The difference in the expected returns between risky assets and Treasury securities is the risk premium investors expect to receive as compensation for the risk they take.

For assets such as publicly traded equities and corporate bonds, it can be difficult to tell the relative contribution of risk premiums and expected future income in causing changes in asset valuations at any point in time. An increase in asset prices might reflect higher expected future payoffs; a decline in the overall level of interest rates, which raises the current value of those future payoffs; a fall in risk premiums; or a combination of these factors.

Asset prices and risk appetite

The Federal Reserve closely monitors measures of risk premiums, which help indicate whether investor risk appetite is rising or falling. When risk appetite is higher, risk premiums are lower, prices of risky assets are higher, and the odds of a large and potentially destabilizing fall in asset prices increases. High risk appetite can also prompt businesses and households to take on more leverage and induce banks and other lenders to increase their risk‐taking.

The risk premium for an asset varies over time and, unlike the price of an asset, cannot be directly observed. Thus, the Federal Reserve takes into account a large set of indicators that provide signals about risk premiums. For example, one measure of the risk premium investors require for holding stocks is the difference between the "earnings yield," which is the ratio of earnings to stock prices, and the long‐term real interest rate. This equity risk premium captures the earnings investors expect to receive by holding equities compared with what they would receive by holding a less risky investment in long‐term government bonds.2 The left panel of figure A shows the distribution of monthly readings on this measure over the past three decades, ordered from low to high. The arrow in the figure shows the most recently available reading. According to this measure, the equity risk premium is around its historical center, suggesting that risk appetite is fairly typical.

A. Measures of Risk Appetite: Expected Equity Risk Premium and Excess Bond Premium
Figure A. Measures of Risk Appetite: Expected Equity Risk Premium
(left panel) and Excess Bond Premium (right panel)

Accessible Version | Return to text

Note: The left panel shows a histogram of a staff estimate of the equity risk premium for January 1995 through February 2021. The equity risk premium estimate shown is the forward earnings-to-price ratio for the S&P 500 less the 10‐year real Treasury yield. Expected real Treasury yields are calculated from a 10‐year consumer price index inflation forecast. The right panel shows a histogram of the excess bond premium measure of Gilchrist and Zakrajšek (2012) for January 1995 through February 2021.

Source: (Left‐hand panel) Federal Reserve Board staff calculations using Refinitiv (formerly Thomson Reuters), Institutional Brokers Estimate System estimates; Department of the Treasury; Federal Reserve Bank of Philadelphia, Survey of Professional Forecasters. (Right‐hand panel) Federal Reserve Board staff calculations based on Lehman Brothers Fixed Income Database (Warga); Intercontinental Exchange, Inc., ICE Data Services; Center for Research in Security Prices, CRSP/Compustat Merged Database, Wharton Research Data Services; Bank of America Merrill Lynch Bond Indices; Moody's; S&P Global Market Intelligence, Compustat.

The right panel shows the distribution of a related measure for the corporate bond market: the excess bond premium.3 This measure captures a component of corporate bond yields that is not explained by risk‐free rates or default risk. By construction, this measure has a historical average of zero. When it is below zero, risk appetite is above that average. As in the left panel, the arrow shows the most recent value, which is not just negative but among the lowest recorded in recent decades, indicating high risk appetite.

The two panels of figure A thus give very different signals about risk appetite based on asset prices. They illustrate why the Federal Reserve also reviews indicators not directly related to an asset's price but that have been associated with periods of elevated risk appetite in the past, such as measures related to trading patterns, underwriting standards, issuance, or investor leverage. For example, indicators pointing to elevated risk appetite in equity markets in early 2021 include the episodes of high trading volumes and price volatility for so‐called meme stocks—stocks that increased in trading volume after going viral on social media.4 Elevated equity issuance through SPACs also suggests a higher‐than‐typical appetite for risk among equity investors (figure B).5

B. Annual Domestic IPOs Scaled by the Market Capitalization of the S&P 500
Figure B. Annual Domestic IPOs Scaled by the Market Capitalization
of the S&P 500

Accessible Version | Return to text

Note: Includes all domestic initial public offerings (IPOs). Special purpose acquisition companies are defined using Security Data Company's (SDC) "blank flag" check. Key identifies bars in order from bottom to top.

Source: SDC Platinum.

Asset prices and persistently low risk‐free interest rates

In recent decades, risk‐free interest rates have declined notably, partly because of a decline in the neutral rate of interest, or the interest rate consistent with the economy being at full employment with 2 percent inflation. Even before the pandemic, a number of estimates found that the neutral rate of interest had declined in recent decades. The decline in the neutral rate of interest likely reflects persistent structural factors such as demographic changes and low productivity growth. While actual interest rates fluctuate with the economic cycle, their trends tend to be driven by the neutral rate of interest. In other words, when, as now, the neutral rate of interest is low, market interest rates also tend to be low.

The connections between persistently low interest rates and risk premiums are not well understood. Persistently low interest rates might contribute to the buildup of financial vulnerabilities through a variety of channels. Because low interest rates tend to be driven by changes in the structure of the economy that reduce expected returns in many asset classes, low interest rates could lead some financial intermediaries to invest in higher‐risk assets to meet fixed return targets.6 By reducing uncertainty about monetary policy, low interest rates could also mute financial market volatility, which could contribute to a buildup in leverage if investors become complacent.7 Beyond asset valuations, low rates could encourage household borrowing, including through mortgages. Higher household borrowing can support spending and economic activity, but excessive borrowing can increase financial vulnerabilities.

At the same time, persistently low interest rates can also reduce financial vulnerabilities—for example, by supporting lower debt service payments. There is also some evidence that unexpected monetary policy easing leads to lower risk premiums, a key channel through which accommodative monetary policy can support the economy.8 However, even large changes in interest rates due to unexpected changes in monetary policy have been found to have only modest effects on equity, corporate bond, and house prices when compared to the overall variation in these asset prices.9

Given these challenges in assessing vulnerabilities associated with risk appetite and asset valuations, the Federal Reserve's financial stability monitoring tracks a wide range of measures related to risk‐taking across financial markets and institutions as well as the resilience of the system to potential drops in asset prices.

1. Discounting refers to the formula for determining the current value of a payment or stream of payments in the future. The discount rate for a risky asset equals the interest rate on a safe asset plus a risk premium, which compensates investors for the risk of losses from holding the risky asset. An alternative theory for asset prices is that an asset price today reflects market participants' estimate of what a potential buyer might be willing to pay for the asset tomorrow. Return to text

2. This indicator is a rough measure of the premium that investors require for holding risky corporate equities. The first step in its calculation is to take the ratio of firm earnings to stock prices as a proxy for expected equity returns. This ratio is calculated as the expected (or "forward") earnings of S&P 500 firms based on analyst estimates, divided by the price of the index. In the second step, the expected equity risk premium is calculated as the earnings yield less the expected 10‐year real Treasury yield as a proxy for expected excess equity returns over a risk‐free rate. Although this indicator provides useful information on the compensation for risk demanded by equity investors, alternative risk premium measures can be constructed using different models and assumptions. Considering a range of these measures can provide valuable additional insights into risk appetite and equity valuation pressures. Return to text

3. See Simon Gilchrist and Egon Zakrajšek (2012), "Credit Spreads and Business Cycle Fluctuations," American Economic Review, vol.102 (June), pp. 1692–720. See also note 6 in the main text. This measure captures a component of corporate bond yields that is not explained by risk‐free rates or default risk. Return to text

4. One such episode occurred in January 2021, when social media activity contributed to extreme fluctuations in stock prices for some companies, resulting in substantial losses for some investors. Return to text

5. SPAC issuance volume remained strong, but, going forward, the pace is reportedly expected to moderate, and the post‐IPO performance of recently issued SPACs has weakened. SPAC issuance took off in mid‐2020 around the exceptional performance of some high‐profile names (for example, DraftKings), with some commentators arguing that SPACs offer a more efficient way to go public than the traditional IPO. However, some academics find that SPACs have substantially higher costs and suggest that the advantages of SPACs may be due to the lower disclosure requirements imposed by law when a company is acquired by a public SPAC, as opposed to undertaking a traditional IPO. See Minmo Gahng, Jay R. Ritter, and Donghang Zhang (2021), "SPACs," unpublished paper, January (revised March 2021); and Michael Klausner, Michael Ohlrogge, and Emily Ruan (forthcoming), "A Sober Look at SPACs," Yale Journal on Regulation. Recent statements issued by the Securities and Exchange Commission highlighted accounting challenges that may be common in SPACs, potential liability risks of SPACs under securities laws, and additional scrutiny that investors might want to use before investing in SPACs. Return to text

6. For example, one study provides evidence that "lower for longer" announcements led to higher risk‐taking by MMFs; see Marco Di Maggio and Marcin Kacperczyk (2017), "The Unintended Consequences of the Zero Lower Bound Policy," Journal of Financial Economics,vol. 123 (January), pp. 59–80. Regarding the connections between low interest rates and risk‐taking by intermediaries, see also Claudio Borio and Haibin Zhu (2012), "Capital Regulation, Risk‐Taking and Monetary Policy: A Missing Link in the Transmission Mechanism?" Journal of Financial Stability, vol. 8 (December), pp. 236–51; Nuno Coimbra and Hélène Rey (2019), "Financial Cycles with Heterogeneous Intermediaries," NBER Working Paper Series 23245 (Cambridge, Mass.: National Bureau of Economic Research, January), https://www.nber.org/papers/w23245; and Lina Lu, Matthew Pritsker, Andrei Zlate, Kenechukwu Anadu, and James Bohn (2019), "Reach for Yield by U.S. Public Pension Funds," Finance and Economics Discussion Series 2019‐048 (Washington: Board of Governors of the Federal Reserve System, June), https://dx.doi.org/10.17016/FEDS.2019.048. Return to text

7. Relatedly, low volatility could lead to higher leverage for intermediaries that face value‐at‐risk constraints. See Tobias Adrian and Hyun Song Shin (2014), "Procyclical Leverage and Value‐at‐Risk," Review of Financial Studies, vol. 27 (February), pp. 373–403. Return to text

8. See Mark Gertler and Peter Karadi (2015), "Monetary Policy Surprises, Credit Costs, and Economic Activity," American Economic Journal: Macroeconomics, vol. 7 (January), pp. 44–76; Simon Gilchrist, David López‐Salido, and Egon Zakrajšek (2015), "Monetary Policy and Real Borrowing Costs at the Zero Lower Bound," American Economic Journal: Macroeconomics,vol. 7 (January), pp. 77–109; and Samuel G. Hanson and Jeremy C. Stein, "Monetary Policy and Long‐Term Real Rates," Journal of Financial Economics, vol. 115 (March), pp. 429–48. Return to text

9. For example, estimates from a range of models indicate that for every 100 basis point decline in the general level of interest rates, house prices increase over the course of several years by roughly 2 to 4 percentage points. By comparison, between 2000 and 2006, house prices increased between 40 and 70 percent, depending on the house price measure used. For further discussion, see Jonathan Goldberg, Elizabeth Klee, Edward Simpson Prescott, and Paul Wood (2020), "Monetary Policy Strategies and Tools: Financial Stability Considerations," Finance and Economics Discussion Series 2020‐074 (Washington: Board of Governors of the Federal Reserve System, August), https://dx.doi.org/10.17016/FEDS.2020.074. Return to text

Commercial real estate valuation pressures appear to remain high

Disruptions caused by the pandemic continue to make it difficult to assess valuations in the CRE sector. Since the November report, CRE price indexes based on transactions recovered from their decline early last year, suggesting elevated pressures (figure 1‐12). Furthermore, capitalization rates, which measure annual income relative to prices of commercial properties, have continued to tick down (figure 1‐13). However, other measures suggest market participants perceive values as having fallen over the past year. For example, an index of the prices of CRE properties administered by real estate investment trusts (REITs), which supplements observed transactions with appraisal information, remains below pre‐pandemic levels.7 Similarly, stock prices of REITs that invest in harder‐hit commercial property sectors have increased since November but generally remain below their respective pre‐pandemic levels.

1‐12. Commercial Real Estate Prices (Real)
Figure 1‐12. Commercial Real Estate Prices (Real)

Accessible Version | Return to text

Note: Series deflated using the consumer price index and seasonally adjusted by Federal Reserve Board staff. The data begin in 1997 for the equal‐weighted curve and 1996 for the value-weighted curve.

Source: CoStar Group, Inc., CoStar Commercial Repeat Sale Indices; Bureau of Labor Statistics, consumer price index via Haver Analytics.

1‐13. Capitalization Rate at Property Purchase
Figure 1‐13. Capitalization Rate at Property Purchase

Accessible Version | Return to text

Note: Data are a 12‐month moving average of weighted capitalization rates in the industrial, retail, office, and multifamily sectors, based on national square footage in 2009.

Source: Real Capital Analytics; Andrew C. Florance, Norm G. Miller, Ruijue Peng, and Jay Spivey (2010), "Slicing, Dicing, and Scoping the Size of the U.S. Commercial Real Estate Market," Journal of Real Estate Portfolio Management,vol. 16 (May–August), pp. 101–18.

Other indicators continue to show strains in CRE markets. Vacancy rates continue to increase, and rent growth has declined further. Additionally, delinquency rates on commercial mortgage‐backed securities (CMBS), which usually contain riskier loans, remain elevated. Finally, the January Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) indicated that banks, on net, reported weaker demand for most CRE loans and tighter lending standards in the fourth quarter of 2020 (figure 1‐14).

1‐14. Change in Bank Standards for Commercial Real Estate Loans
Figure 1‐14. Change in Bank Standards for Commercial Real Estate
Loans

Accessible Version | Return to text

Note: Banks' responses are weighted by their commercial real estate loan market shares. The shaded bars with top caps indicate periods of business recession as defined by the National Bureau of Economic Research (NBER): March 2001–November 2001, December 2007–June 2009, and February 2020–present. As of the publication of this report, the NBER has not declared an end to the current recession. Survey respondents to the Senior Loan Officer Opinion Survey on Bank Lending Practices are asked about the changes over the quarter.

Source: Federal Reserve Board (FRB), Senior Loan Officer Opinion Survey on Bank Lending Practices; FRB staff calculations.

Farmland prices remain high relative to rents

Farmland prices continued their slow decline at the national level—and at a slightly faster pace in several midwestern states—through the second quarter of 2020 (figure 1‐15). Recent estimates from Reserve Bank surveys suggest prices edged up in the second half of 2020 in the midwestern states where farmland values are more elevated. Overall, the ratio of farmland prices to rents remained elevated relative to historical norms (figure 1‐16).

1‐15. Farmland Prices
Figure 1‐15. Farmland Prices

Accessible Version | Return to text

Note: The data for the United States start in 1997. Midwest index is a weighted average of Corn Belt and Great Plains states that comes from staff calculations. Values are given in real terms. The data extend through July 2020.

Source: Department of Agriculture; Federal Reserve Bank of Minneapolis staff calculations.

1‐16. Farmland Price‐to‐Rent Ratio
Figure 1‐16. Farmland Price‐to‐Rent Ratio

Accessible Version | Return to text

Note: The data for the United States start in 1998. Midwest index is the weighted average of Corn Belt and Great Plains states. The data extend through July 2020.

Source: Department of Agriculture; Federal Reserve Bank of Minneapolis staff calculations.

House price growth continued to increase, and valuations appear high relative to history

The average growth rate of home prices increased significantly since the previous report (figure 1‐17). Nationwide, house price valuation measures moved up but remain well below the peak of the mid‐2000s (figure 1‐18). House price increases are widespread across regions and property types, and price‐to‐rent ratios also generally increased across regional markets (figure 1‐19).

1‐17. Growth of Nominal Prices of Existing Homes
Figure 1‐17. Growth of Nominal Prices of Existing Homes

Accessible Version | Return to text

Source: CoreLogic Real Estate Data; Zillow, Inc., Zillow Real Estate Data.

1‐18. House Price Valuation Measure
Figure 1‐18. House Price Valuation Measure

Accessible Version | Return to text

Note: Valuation is measured as the deviation from the long‐run relationship between the price‐to‐rent ratio and real 10‐year Treasury yield.

Source: For house prices, Zillow; for rent data, Bureau of Labor Statistics.

1‐19. Selected Local Housing Price‐to‐Rent Ratio Indexes
Figure 1-19. Selected Local Housing Price-to-Rent Ratio Indexes

Accessible Version | Return to text

Note: The data are seasonally adjusted. The data for Phoenix start in 2002. Monthly rent values for Phoenix are interpolated from semiannual numbers. Percentiles are based on 19 metropolitan statistical areas.

Source: For house prices, Zillow; for rent data, Bureau of Labor Statistics.

Low levels of interest rates have likely supported robust housing demand. However, downside risks to the sector remain, given the unusually large number of mortgage loans in forbearance programs and the uncertainty around their ultimate repayment.

References

 3. Treasury term premiums capture the difference between the yield that investors require for holding longer‐term Treasury securities and the expected yield from rolling over shorter‐dated ones. Return to text

 4. Market depth indicates the quantity of an asset available to buy or sell at the best posted bid and ask prices. Return to text

 5. Spreads between yields on corporate bonds and comparable‐maturity Treasury securities reflect the extra compensation investors require to hold debt that is subject to corporate default or liquidity risks. Return to text

 6. For a description of the excess bond premium, see Simon Gilchrist and Egon Zakrajšek (2012), "Credit Spreads and Business Cycle Fluctuations," American Economic Review, vol. 102 (June), pp. 1692–720. Return to text

 7. The Green Street price index remained below its pre‐pandemic level in February. This index is appraisal based, using both sales and nonsales information to track prices of properties managed by REITs. Return to text

Back to Top
Last Update: May 13, 2021