Cap Rates Approach Stability: CBRE

LOS ANGELES—Cap rates continued narrowing across key markets and property types in the first half of this year, according to CBRE's latest survey of investment trends in the US and Canada. However, CBRE sees the rate of compression slowing down compared to previous surveys, thus signaling that the capital markets cycle is “close to reaching stabilization in terms of pricing.” The survey predicts that cap rates will remain stable in the year's second half in about 75% of the 56 US and Canadian markets it covers.

That being said, CBRE's North America Cap Rate Survey for January through June of this year also found “considerable variation” within the theme of stabilization in cap rate pricing. In the office sector, first example, cap rates on class A CBD assets declined in nine markets during the first half of 2015, while rising in 16 and remaining stable in 17. That led CBRE to post an average increase of six basis points for these properties, while cap rates on class B and C assets compressed during the same time period.

Conversely, retail saw the largest—if modest—declines in cap rates of any property sector, led by class B assets with compression of 24 bps over the year's first six months. That's the case even though the year-over-year volume increase for retail properties was far smaller than that of any other sector.

Average cap rates don't get any narrower than the 4.2% reported by CBRE for class A multifamily product in Tier I metro areas. In terms of individual markets, San Francisco comes in considerably lower at 3.75% for stabilized class A infill assets. Yet the apartment sector on the whole saw less compression than other property types, ranging between eight and 14 bps.

Slightly less moderate were the cap rate declines seen among industrial properties, ranging from 10 to 19 bps. The sector's 70% Y-O-Y increase in sales volume includes entity-level acquisitions, led by the $8.1-billion trade of the Blackstone Group's IndCor platform to a partnership of GIC and Global Logistics Properties.

The survey notes that nearly all macroeconomists expects interest rates to begin rising modestly by year's end and in the years to come. “The difference among the opinions is how much and when,” according to the survey.

While the two key metrics are the federal funds rate and market-based yields on 10-year Treasuries, CBRE sees the relationship between cap rates and Treasury yields as especially relevant to the current market. With CBRE Econometric Advisors forecasting moderate rises in T-note yields over the next 18 months, ending 2016 at 3.19%, the question then becomes: will this automatically translate into higher cap rates? “The qualified answer is 'no,'” according to CBRE.

By way of supporting this statement, the survey graphs the historical relationship between 10-year Treasuries and cap rates on multifamily and industrial properties, using data from the National Council on Real Estate Investment Fiduciaries. It found that spreads were tightest during the peak of the 2007 investment boom and widest at the end of the early-2000s recession.

“In other words, during periods of peak economic performance and investment, spreads between the 10-year Treasury and cap rates are typically compressed,” according to the survey. Since real estate is typically perceived as lower risk during these periods, leading to a more competitive investment climate, “the near-term outlook of higher interest rates is not necessarily going to translate into higher cap rates if the rates come from stronger economic growth, as expected, as opposed to an unexpected shock to the economic system.”