The Lower Foreign Purchases of Treasurys Is Bad News for CRE

Over the last ten years, foreign buyers have come to have far less appetite for U.S. government debt, as the Wall Street Journal reported.

“U.S. issuance is way up, and foreign demand hasn’t gone up,” Brad Setser, senior fellow at the Council on Foreign Relations, told the WSJ. “And in some key categories—notably Japan and China—they don’t seem likely to be net buyers going forward.”

This is bad news for commercial real estate in two ways.

First is the interplay of supply and demand and how that affects interest rates. The Federal Reserve has significant sway on rates through setting the benchmark federal funds rate. But that isn’t the only way borrowing costs for CRE increase. Another is through movement on Treasurys yields.

Investors make decisions based on risk-adjusted returns. There has to be enough return from investments to justify the risk they bring, and the basis for decisions is typically U.S. government debt, which means Treasurys. The higher the yields Treasurys offer, the more return investors expect from investments.

This is where Treasurys’ desirability among long-time investors on one hand and CRE on the other intersect. The less demand for federal debt there is, the higher yields have to rise to attract buyers. At the same time, supply is increasing, with the government still catching up the amount of debt it might have previously issued except that Congress had kept putting off a debt ceiling impasse, meaning the Treasury had to halt its regular debt sales. That has meant a larger amount is still being issued now, boosting supply at the very moment that demand has dropped.

Even though the increase in yields has temporarily reversed, this is unlikely to be an ongoing result. Treasurys’ yields will remain high, and investors will demand commensurate compensation for riskier investments. As Treasury yields stay higher than they have been for years, financing any real estate property becomes more expensive.

The second way this becomes a problem is more general. Treasurys are the main way the government borrows money to pay off old debts. For years, especially during the pandemic during zero interest rate policy, debt was cheap. But higher Treasury yields make the debt far more expensive. A greater portion of the budget has to go to debt service. That leaves less available for other things like general government investment and the ability to provide tax incentives that frequently help the CRE industry.