The mystery of low natural interest rates has become the topic of the hour, and everyone is perplexed by the mystery. Why are interest rates so low? Has anybody mentioned housing? This virus infected everyone’s brain so that we can only believe houses are too expensive or too plentiful, but not the other way around. So, nobody seems to notice that the return on real estate investments is very high.

I have posted some version of this graph several times. In the 1970s & 1980s, its tough to get a read on it because there weren’t markets in inflation-adjusted treasury bonds at the time. But, there is clearly a relationship between real estate returns and real interest rates. Why wouldn’t there be?

And this relationship broke down at the end of 2007 when we shut down real estate credit markets. The lack of access to home ownership made real estate returns go up while bond yields were going down. This is an important signal of financial breakdown, and nobody seems to notice.

So, no. Natural interest rates are not low. The real long term natural rate right now is about 2.5%. If you have tons of cash or you can run the gauntlet and get a mortgage, or if you are an institituional investor going through the difficult organizational process of buying up billions of dollars of rental homes, you get the preferred rate of 4% real returns.

If you aren’t, then you get the “class B” shares of low risk fixed income, which pay about 1% real (3% nominal).

The real estate market is much larger than the treasuries market. This is a big deal. This should be just about the only thing anybody is talking about regarding natural rates. Household real estate is worth about $25 trillion. If we hadn’t stopped building homes a decade ago, and if home prices did not contain an access premium, there would be more than $40 trillion in real estate. It dwarfs the size of the treasury market. That’s why rates have not reacted to large deficits. The federal government couldn’t realistically accumulate enough debt to make up for the gaping hole we have created in real capital.

We need to make some mortgages and build some houses. We will not be doing that, because of the virus. So, it looks to me like we will be wondering about the big interest rate mystery for another decade.