Multifamily cap rates in a rising interest rate environment
The recent rise in long term interest rates has led investors to question the impact of this trend on commercial real estate values.
Conventional wisdom states that interest rates are positively correlated to real estate cap rates. Therefore, when treasury yields rise, cap rates would be expected to rise in tandem, and vice versa. Given the collective value of commercial real estate in the US, estimated at $9.9 trillion as of third quarter 2018 by CoStar Portfolio Strategy, it is worth taking a moment to review the available data to understand if this correlation can be demonstrated. Additionally, some basic calculations can help us under- stand the materiality of potential cap rate moves and the changes in NOI (Net Operating Income) required to off- set potential falls in value from rising cap rates.
Multifamily cap rates and Treasury rates – a volatile relationship
For the following series of analyses, multifamily cap rates will be used, since it is one of the largest real estate asset classes in the US. Those who agree with the conventional wisdom that states that cap rates are positively correlated with interest rates (defined as the 10-year Treasury rate) are correct – 60% of the time. Those who think that multifamily cap rates are negatively correlated with interest rates, are correct – 40% of the time. The relationship between these two metrics varies greatly depending on the quarter or year in question.
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