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An argument can be made for downward pressure on cap rates for popular assets like industrial and multifamily and recovery types like senior housing and retail.
Rising interest rates are unlikely to push cap rates up this year, counter to what many investors may believe, according to a new analysis from Marcus & Millichap.
The interest rate on ten-year Treasuries has nearly tripled since the end of July when it was at an all-time low near 50 basis points. But rates remain near historical lows, a good sign for investors, according to John Chang, Senior Vice President and Director of Research Services at Marcus & Millichap.
It’s true, Chang says, that there’s been upward pressure on rates for the last six months, and some economists have increased 2021 forecasts to the 8% range.
And “normally that kind of growth—especially when fueled by trillions in stimulus—will put upward pressure on inflation, and of course, the counterbalance on inflation is to push interest rates up,” he says. “But that said, inflation remains exceptionally low,” at a “tame” 1.3%. Generally, the Fed wants to see inflation in the 2% range, according to Chang.
So why exactly are rates rising? “Falling uncertainty and expectations of growth,” Chang said. “Because we can see the light at the end of the pandemic tunnel and the investor market expects growth to be strong in 2021, money is flowing out of safe havens like bonds and Treasuries and into growth investments like the stock market and yes, real estate. That flow of money is putting upward pressure on interest rates”
Chang also challenges the commonly-held investor beliefs that cap rates move with interest rates. “Historically, that’s not true,” he said. “Yes, over decades both have trended together. But when you look at the year to year movement the spread narrows and expands.”
For example, in pre-recession 2007, the yield spread narrowed to just 200 bps, while it opened to 580 bps during the Great Financial Crisis when interest rates went down and cap rates went up.
The current spread is 480 bps, Chang said. “Economists have a bullish outlook for 2021,” he noted. “Liquidity is good and rates low. Investors are increasingly less fearful of the pandemic.”
Chang posits that even if rates rise, they probably won’t push the caps rate up. He says an argument can be made for downward pressure on cap rates for popular assets like industrial and multifamily and recovery types like senior housing and retail.
“I encourage every investor to set aside the idea that interest rates and cap rates will move together,” Chang said. “Focus instead on the outlook for each asset. What’s on the horizon for demand driers and supply risks? That combination can put the long-term context of an asset into a much better perspective.”
Source: Here’s What Rising Interest Rates Mean For Cap Rates