Cap Rates in a Rising Interest Rate Environment
Great overview of the recent impact on cap rates in commercial real estate from rising rates. In short, there has been no impact at all and cap rates continue to move lower in most sectors of the CRE world.
From the article:
It is still early in the cycle of interest rate increases, and we expect more to come, both from policy actions by the Federal Reserve to raise its target for short-term interest rates and also the market-driven increases in long-term interest rates. There has been enough of a rise in both short-term and long-term rates in recent months, however, to assess where we stand. Yields on the 10-year Treasury note are 70 bps or more above where they were six months ago, and nearly 150 bps above their low point in mid-2016. The question on everyone’s mind is, will this drive up cap rates, possibly causing property prices to fall?
The answer, so far, is no. In fact, cap rates through February, 2018, have continued to decline in the apartment, office and hotel sectors, while edging higher in industrial and retail property markets. Despite the considerable rise in long-term yields over the past year or more, cap rates in the apartment market reached a new low for the cycle in February, and cap rates for the industrial, office and retail markets remain near their lows.
The continued downtrend of cap rates should not be that surprising, however, as the spread between cap rates and Treasury yields has been much wider than normal, giving the real estate market a healthy cushion against rising interest rates. Only recently, in fact, have spreads to Treasuries moved back into the range where they were in the mid-2000s.
Spreads remain wide, but there is less margin than there was six months ago. We expect future increases in interest rates to be gradual but steady, which will likely be accompanied by some further narrowing of cap rate spreads. A sharper increase in interest rates, while unlikely, could lead to some disruption in cap rates, including a reversal of some or all of the recent increases in property prices.