By Mark Heschmeyer

QE1 and QE2 are dead; long live QE3! That, at least, is the hope among those in the commercial real estate industry.

Though a third round of quantitative easing (QE3) had been long anticipated as the U.S. economy, housing and jobs market have continued to seek firm footing for a sustained recovery, the Federal Reserve announcement last week of another major stimulous plan had some nice surprises for the real estate industry: it was larger than expected, and more importantly according to analysts, it was open ended. The previous two stimulus efforts had scheduled start and end times.

Under the latest plan, the Federal Reserve agreed to purchase additional agency mortgage-backed securities at a pace of $40 billion per month. And, if the outlook for the labor market does not improve substantially, the Fed said it will continue that level of purchasing, or perhaps even increase it, until “improvement is achieved in a context of price stability.”

More Than a Sugar Rush

“It’s widely recognized that the Federal Reserve’s rounds of quantitative easing (QE), including ‘Operation Twist,’ were designed to flatten the yield curve and lift up asset prices, with the ultimate goal of generating economic growth,” said John O’Callahan, capital markets strategist, for CoStar Group’s PPR.

The two previous rounds of quantitative easing did boost asset prices appreciably, O’Callahan noted, but those increases weren’t sustained when the stimulus rounds ended, resulting in limited success in generating economic growth.

“Investment returns of 40% or more for riskier assets during QE1 were largely a result of a bounce-back from the lows caused by investor panic in late 2008 through early 2009,” O’Callahan said. “But QE1 arguably boosted prices more than they would otherwise have risen during that period, as perhaps evidenced by the subsequent price decline following the end of QE1.”

“The overall impact of QE becomes clearer upon examining QE2, which was launched in isolation in late 2010. Prices of equities and high-yield bonds, including riskier CMBS, gained a respectable 12%-25%,” he added. “Following the end of QE2, most of the gains subsequently faded, with a small net impact for most of the riskier asset classes.”

“If history is a guide, we could expect additional near-term price gains for riskier assets, at least for a few more months,” O’Callahan said.

However, because QE3 seems to be open ended and more flexible than what was expected, the price gains could go on longer, he speculated.

“The ongoing flow of $40 billion/month is pretty significant,” O’Callahan said. “It looks to be between 25-30% of monthly new issuance, on average, assuming refi volume continues to be strong in the future, which means the Fed will crowd out other investors such as some mortgage REITs.”

Could Be Positive for Equity REITs

In its analysis of QE3, Fitch Ratings said it believes QE3 could also have a positive influence on some structured products and equity real estate investment trusts (REITs).

“In our view, QE3 could have a more meaningful impact on some REIT sectors versus others,” Fitch analyst wrote. “If QE3 achieves the desired effect on the U.S. economy, equity REITs would benefit in the long term, approximately 12 to 24 months later.”

Read entire Costar article here.