It's become something of a running joke by now: Economic prognosticators keep forecasting higher interest rates, yet the market refuses to yield. Each time interest rates on 10-year Treasury notes go up, they come right back down again, postponing the correction that so many view as inevitable. Even Federal Reserve Board Chairman Alan Greenspan has called the situation a "conundrum," which is just another way of saying that long-term interest rates surely ought to be higher than they actually are.

However much amusement this has provided at forecasters' expense, the underlying issue is both serious and significant to apartment executives: Can the current era of generationally low interest rates continue indefinitely, or will we soon find ourselves in a period where interest rates remind us not of the 1960s, but of the 1990s?

Michael D'Antuono

Interest and Inflation

It's hard to overstate the importance of interest rates on apartment activity. The cost of finance affects both the cost (and thus the profitability) of development and the price offered by buyers of apartments, which in turn affects the price of apartment properties. It also affects the cost of purchasing a house, which influences the demand for apartments.

Through the first seven months of 2005, the yield on the 10-year Treasury has ranged from about 4.0 percent to 4.5 percent and averaged just less than 4.25 percent. This is about the same as in 2004, though up slightly from 2003. Before that, however, you have to go back to 1964 to find a lower annual figure. The accompanying chart (see "Unexpected Interest," page 40) shows just how unusually low today's rates are.

Inflation tends to reduce the burden of interest rates on borrowers. They can get cash in hand today, but pay it back over time with money that is not worth as much due to inflation. To adjust for this impact of inflation, economists often focus on "real" interest rates, which is the amount by which interest rates exceed inflation. Put differently, interest rates are made up of two components: the "real" rate and an "inflation premium." Over the first half of 2005, inflation has averaged about 3 percent, resulting in a real 10-year Treasury rate of about 1.25 percent.

By this measure as well, current rates are uncharacteristically low.