By Jim Costello on July 18th, 2019
Interest rates have been on a wild ride over the last year, but cap rates nationally have not. Preliminary figures for Q2’19 show that cap rates were flat-to-declining in this period of wild swings in the level of the 10yr US Treasury. A national trend is one thing, but what matters for commercial real estate investors is what is happening in the markets where one’s portfolio is located.
Changes in the composition of what sells each period can introduce noise in national cap rate trends. If more deals are seen in markets that are typically inexpensive, or more deals are seen for assets that are older, cap rates might seem to be creeping upward.
A new tool being introduced in RCA’s US Capital Trends report next week controls for quality issues in cap rate observations and points to a generally flat trend in cap rates over the last year.
The issue of asset quality is vitally important for the performance of retail property as there are clear winners and losers in this sector at the asset level. Looking at retail trends across markets using this quality-adjusted cap rate figure, few markets exhibited significant moves over the last year.
Each dot represents one of 58 unique markets across the U.S. and any dot above the line is a market where cap rates were higher in Q2’19 than in Q2’18.
In 23 out of the 58 markets analyzed, retail cap rates fell over the last year. One pattern that was evident is that this compression was more pronounced in the markets of the 6 Major Metros of the U.S. Retail cap rates compressed in seven out of 14 markets within these areas, which are areas that typically have better trends in personal income than the rest of the country.
Even in the markets where cap rates did change notably, it was not at the extremes seen with the 10yr UST. From June ’18 to November ’18, the 10yr UST climbed 20 bps. The 10yr UST then plunged 105 bps from November ’18 to June ’19. Despite those wild ups and downs, cap rates barely budged. That interest rate roller coaster is, in a sense, the driver of flat cap rate trends.
With volatility dominating the investment world, both buyers and sellers took a wait-and-see approach before making major moves in the marketplace. The US Capital Trends report to be released next week will point to a generally declining trend in sales volume for H1’19. This dip will be seen for all sectors except office, apartment and seniors housing & care.
The wild ride for interest rates, though, may be over. Statements by Federal Reserve Chairman Powell suggest an easing of the fed funds rate later this year. If and when the interest rate environment stabilizes, commercial real estate investors may be more willing to make decisions.
The new edition of US Capital Trends will be released July 24. In this issue we introduce RCA’s new suite of enhanced cap rate and pricing time series, as an alternative to existing average cap rates and pricing data sets, and with the goal of identifying underlying price signals.
Also on RCA Insights: