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Relationship between interest rates and commercial real estate cap rates.

We came across a great analysis on the somewhat tenuous relationship between the 10-year US Treasury yield and the average capitalization rate (cap rate) of US commercial real estate. Written by Paul Muchakaa at Morgan Stanley, his thoughts are neatly summarized in this paragraph:

"The current environment, where credit availability is growing, construction lending remains muted and demand is outstripping supply, may mitigate or even potentially offset any rise in cap rates. Thus, a singular focus on Treasury rate movements to the exclusion of other key explanatory variables may lead to sub optimal investment decisions."

In other words, the cap rate that investors demand from commercial real estate - whether multi family, retail, or office - is impacted by many factors beyond merely the current US interest rate environment.

It is also interesting how the spread between the 10 year yield and the average commercial cap rate is well within its long term range of 250 to 450 basis points - currently we are approximately 450 basis points over the 10 year - which should provide a nice buffer for real estate valuations even with a move up in rates of about a point.

Here is a link to the article:

Also, here is a great little chart from a piece last year in Seeking Alpha by Chilton REIT team which is looking at the REIT Implied Cap Rate vs. the 10 - year.

Link to the article:

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