This article was posted on Saturday, Aug 01, 2015

There is both empirical and supporting statistical data indicating that interest rates might stay relatively low over the next ten years. There will be an overall uptrend (with fluctuations), but interest rates a decade from now are projected to be less than the average since 1956. We’ll first discuss the data and then use what we’ve found to establish a metric that might help to measure change in portfolio value. 

Empirical Data

World War II ended in 1945. Nine months and twenty minutes later the first wave of the Baby Boom generation filled hospital nurseries. High birth rates continued until 1964, when post-war births constituted 40% of the population.

As we talked about several years ago, this post-war demographic marched through life in almost perfect syncopation. Among middle and upper-middle class families the average age of the parents when the first child is born is 28. Their first house is purchased when the parents are 31. Eight or nine years later when the kids start to need more room the parents move the family to a bigger house. Mortgage debt peaks at age 41. Overall spending peaks around age 46.

Notice that middle class people do predictable things at predictable times in their lives. These things establish trends that affect sectors of our economy decades in advance of need. There’s a “Baby Boom” and thoughtful people recognize that in six years we’ll need more elementary schools. In 18 years we’ll need blue collar jobs. Later, when the college kids graduate, we’ll need white collar jobs or, depending on the political party in power, at least a good excuse. A few years later when the Gen-X babies come we’ll need new subdivisions in Santa Clarita. A little after that the Baby Boomer grandparents move to an old folk’s home and, finally, to a pretty urn above the daughter’s fireplace.

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We’re not talking about a normalized birthrate, where population growth remains relatively steady. An example of normal population growth begins when 100 kids sneak their peanut butter and jelly sandwiches into Sister Mary Theresa’s first grade. When they graduate from college Sister Mary has 117 new six year olds to civilize. That rate of growth pretty much reflects the change in the United States population from 1990 (248,710,000) to 2010 (308,745,000). The normal rate of growth in the United States from all sources was just over two percent per year, compounded, legal immigration included.

The Baby Boom was far more dramatic. Between 1946 and 1964 there were 79,000,000 new babies born. Ok, I know the Baby Boom happened over an 18 year period but that’s still (cumulatively) a bunch of diapers, peanut butter and jelly, prom dresses, additional cars, dorm fees and wedding expenses. And these items happened sequentially at roughly predictable intervals. It all requires money, and the parents are responsible for the tab. Young people (under 46, on average) spend big money raising a family. In our culture, almost all of it is financed.

The Federal Reserve is our country’s central bank, and for all the obvious reasons prefers inflation. Just by itself, a 7% inflation rate over the next 10 years would reduce that troublesome national debt by half. So the government can be expected to seek a politically acceptable level of inflation. “Politically acceptable” means as much as they think they can get away with. The government sector is biased towards inflation, but the private sector, with about 2/3rds of the economy, is currently deflating. The government’s one-third share is expanding, but the larger private sector is contracting. The reason is that the 79,000,000 Baby Boomers, every one of them, are over 46. They no longer are financing the expenses associated with young people with families. They have arrived at middle age, seen the specter of an underfunded retirement twenty years away, reflected on how quickly the past 20 years have evaporated, and now are desperate to work out a way to save as much money as possible. That usually starts with spending as little as possible.

After the Boomer’s children (the Gen X’ers) graduate, the Boomer’s – predictably – begin preparing for retirement. This has serious economic consequences. Pay off debt. Downsize the house. Put more into the ol’ retirement account. Call Klarise for an apartment loan.

Sidebar:  Apartment ownership benefits from inflation, we know that. But in a low growth economy why would someone want to buy a building without the inflation rider? Because the tenants pay the building off. It doesn’t get any simpler than that. With a little planning we can adjust to a slow economy and still have a perfectly satisfactory investment.

Hypothetical example: If you buy a $1,000,000 building and the tenants pay it off in 20 years, even if there isn’t a nickel of cash flow that entire 20 years, even if the property doesn’t appreciate a dime, when the tenants make that last payment you’ll have the *unmortgaged* cash flows from an eight unit building to ease your declining years.

“Go sit on the front porch and wave at the cars, Buttercup,” your loving husband says, “I’ll bring the mint juleps.” 

Switching gears from the economy to population numbers, the most recent census (2010) reported the US population at 308,745,000. Boomers are about 25% of the total (79 million divided by 309 million = 25.6%) and the Boomers are quickly paying off debt. That means that those folks are not meaningfully contributing to the economy (if you’re paying something off, you’re not buying a new one . . . and only new ones count). We can’t look to the Gen X’ers for salvation. The Gen X’ers are the first generation in American history that’s smaller than its predecessor.

The reason nothing happens is that old people don’t buy bigger things. By the time the kids leave for college the typical middle class couple is living in a 2,300 sq. ft. house. The kids leave home and the parents downsize to a 1,200 sq. ft. condominium. What do they need all those bedrooms for? The kids don’t even visit anymore. Fifteen years later the parents are in a 200 sq. ft. room in an assisted living facility. Another decade and there’s that comfortable urn we talked about.

Boomers are not buying living area. They’re selling it. Downsizing is the future of real estate. For every young couple having babies there are one or more older couples drifting into a nursing home.

Ok. So a working hypothesis appears to be this: We have more thrifty old people than spendy young people, so the economy will continue to have to work hard just to stay on the treadmill. It might have to do that for a long time, and there’s very little the government can do about it. Look at the failures of QE I, II, and III. All that money was spent and the economy is still just running in place. A way to quantify the state of the economy is to look at the Federal Funds Rate (FFR).

Statistical Data

What is the Federal Funds Rate? Banks accept money from depositors (paying a low interest rate) and lend it out to other customers (at a higher rate). The difference between the interest received and the interest paid (the gross interest margin) goes to gross profit. Since a high gross profit is better than a low one, it is obviously to the bank’s interest to lend out every penny of deposits they can.

But the banks can’t just lend it all out. The Federal Reserve won’t let them. If the banks could lend out every bit of their deposits they would not be able to immediately honor withdrawals. The checks we write could not be cashed. They would probably be put on “hold” for a week or two until some customer makes a loan payment giving the bank the cash to finally pay the check we wrote in the middle of last month. Think what that would do to the economy! So the Fed has a rule: banks can’t lend out the entirety of every deposit that comes in.

Ours is a fractional banking system. That means a portion of a bank’s total deposits must be maintained in an account at the Federal Reserve. That sum is called the “reserve account”. It is the legal minimum the bank must have available to honor withdrawals. The amount varies from one day to another, depending on the ebb and flow of loan payments versus deposits. When a bank ends the day with more than the minimum in their reserve account they can lend that excess overnight to another bank in the Federal Reserve system. The Fed determines the interest rate on these super short term loans. That rate is called the Federal Funds Rate (FFR).

Why is it Important? The Federal Funds Rate establishes the base interest rate for our economy. The Federal Funds Rate applies to a short term loan (time risk is minimal) made to a strong institutional borrower (credit risk is token). They don’t call it this but functionally the Federal Funds Rate is the national Index rate. It is difficult to think of a reason for a bank to lend money at less than the interbank overnight rate. The final interest rate of every loan consists of the Federal Funds Rate plus a margin. The margin itself is usually fixed, but interest rates change when the index (in this example, the Federal Funds Rate) changes. If the FFR increases, rates go up. If the Federal Funds Rate goes down, rates decline. Over the long term the range has been from 0.09% to 16.39%. The average over the last 59 years (since 1955) has been 5.20%. The last couple of years it has been 0.25% (25 basis points). 

Current Forecast

Two well respected economists recently published a letter, for the benefit of the institution that employs them, giving their ten-year interest rate forecast. Although the FFR long-term average has been 5.20%, these economists do not think the Federal Funds Rate will exceed 3.50% until sometime after 2025.

In other words, these economists forecast that what amounts to the national interest rate index, the FFR, will not reach its long term average during the next decade. This is consistent with the empirical data already discussed.

A Federal Funds Rate greater than the long term average indicates an inflationary economy. A FFR beneath the mean demonstrates a weak economy. A moderate Federal Funds Rate around the long-term average of 5.20% means the economy is doing very well, thank you, and please pass the middle bowl of porridge. It’s neither too inflationary nor too lethargic. If the FFR only returned to its long term average, interest rates would increase 4.95% from current levels (5.20% minus 0.25%). But, as noted, these two thoughtful economists do not think that’s likely, at least over their event horizon. 


Due to unfavorable demographics we can expect the economy to be biased towards low growth as long as interest rates do not materially exceed the rate of inflation. Assuming no economic shocks, at least one credible study indicates rates will remain below their 59 year average through 2025. Within that ceiling, however, rates are expected to trend upwards. The current Federal Funds Rate of 0.25% is forecast to approach 3.50% a decade from now. The capitalized values of streams of income (i.e., apartment buildings) would be negatively affected by increased interest rates.

It’s always subject to confirming data, but a rule of thumb is that value can be maintained if net operating income (NOI) rises with the index of the underlying loan. Since we understand that the Federal Funds Rate is a proxy for the foundational index, the thoughtful owner will attempt to raise his net income at least as much as the annual increase in the Federal Funds Rate. 

This article is for informational purposes only and is not intended as professional advice. For specific circumstances, please contact an appropriately licensed professional. 

Klarise Yahya is a Commercial Mortgage Broker. If you are thinking of refinancing or purchasing five units or more, Klarise Yahya can probably help. Find out how much you can borrow. For a complimentary mortgage analysis, please call her at (818) 414-7830 or email [email protected] 

If you’ve missed some of the prior articles, basic guidelines on successful investing are in my book “Stairway to Wealth” available at