Climbing 10-Year Treasury Yields Are a Warning Sign
The impact on asset values won’t be as bad as some think, but it still could make CRE financing more of a challenge.
There was a bit of a chill earlier this month in Treasury yields.
“At 4.35% on August 21, the 10-year Treasury rate reached its highest level since 2007 before retreating to 4.24% on August 24,” wrote at the time Richard Barkham, global chief economist for CBRE. “Some economists predict that the 10-year rate could hit 4.75% or higher — more than double the 2.24% average over the past 10 years.”
A few notes. According to the data at the Treasury’s website, the rate at the end of August 21 was 4.34%. It may be that the 4.35% reference was an intraday rate, which would still be worth noting, but even 4.34% is a high point since November 6, 2007. By August 24, the rate was 4.23%, but that was still the highest since November 9, 2007.
“Econometric evidence suggests that every 100-basis-point increase in long-term interest rates results in a 60-basis-point rise in commercial real estate capitalization rates,” Barkham said. “So, a predicted rise in the 10-year rate to 4.75% from 2.2% would cause a 150-basis-point increase in the average cap rate. Under this scenario, a prime asset trading at a 4.5% cap rate would now trade at a 6% rate, equivalent to an approximate 25% fall in capital values. While not a disaster for commercial real estate, it would cause pain for some investors and some losses in the banking sector.”
CBRE projects, however, that when the Fed eventually gets the level of inflation that it wants, the 10-year’s yield will return to about 3.5% over the next five years and then settle at 3.25% by 2027, meaning average cap rates will be 75 basis points higher than during the past decade, which is an asset value reduction of 12.5%.
However, there’s a secondary impact of the 10-year’s activity that could have a shorter-term impact: volatility.
When the 10-year’s yield rises, it puts pressure on financing costs because it is a standard measure of alternative investment value. An investor wants risk-adjusted returns that are better than buying Treasurys. Otherwise, why put money into a different investment when you could pick as close to a risk-free way to make money as possible.
Higher 10-year yields are something that investors, borrowers, and lenders can work around. Sudden shifts, though, throw off everyone’s planning, inducing many to step back and wait.