What happens to commercial real estate cap rates when the 10-year Treasury yield shifts? There’s no single answer, but we do see trends emerge over time. According to CBRE Econometric Advisors, looking at data since 1995, there’s a notable connection, though it varies depending on the type of property.
On average, for every 100 basis point change in the 10-year yield, cap rates follow suit in the same direction. Higher yields push cap rates up, and when yields drop, so do the cap rates. Here’s how that shakes out by sector: retail sees a 78-basis point shift, multifamily moves 75, office 70, and industrial a smaller 41 basis points.
Why such a smaller move for industrial? It all comes down to demand patterns. Before 2010, industrial wasn’t exactly hot property – not for investors or companies. As a result, its cap rates were less affected by the usual market cycles. Then, during the pandemic, e-commerce transformed the sector into a must-have, which curbed cap rate growth, improved net operating income (NOI), and trimmed down risk premiums. So, while industrial experienced extreme highs and lows in demand, these forces balanced out, moderating the overall impact of macroeconomic factors on cap rates.
But remember, the relationship between cap rates and Treasury yields can change. For example, during economic slowdowns, the spread between cap rates and the 10-year yield tends to widen, while in recoveries, it narrows. CBRE also predicts that federal budget deficits will play a part here, potentially slowing cap rate declines and stabilizing them at higher levels than we saw pre-pandemic. This is due to the ongoing higher interest rate environment.
The 10-year yield isn’t the only driver, though. CBRE dug deeper into other factors, and the second strongest driver is the real rent ratio, which measures how current real rents compare to historical averages for a given market. Here, the relationship is inverse – as real rents rise, cap rates fall. Office space is most sensitive to this, with a 69-basis point change, followed by multifamily at 54, industrial at 39, and retail at 38.
Inflation also plays a role, with inverse effects across all sectors. Industrial is again the strongest at a 41-basis point response, followed by retail (31), office (28), and multifamily (20). It’s no surprise that the 10-year yield has such a strong influence—long-term interest rates determine the cost of acquiring properties, so buyers and investors adjust their cap rate expectations accordingly.
Additional Insights on Multifamily Cap Rates in 2024
Multifamily cap rates have been adjusting in lockstep with the rising 10-year Treasury yield, which touched its highest level since 2007, peaking near 4.87% recently. Multifamily cap rates have risen to about 5.1% in response, narrowing the spread between cap rates and Treasury yields to around 30 basis points. This tightening spread makes multifamily deals harder to pencil out, especially when paired with slower rent growth and higher vacancy rates in many markets. However, the long-term outlook still shows that multifamily real estate remains attractive, driven by strong demand and housing shortages in key regions.
Interestingly, despite the higher costs of capital, small multifamily properties have remained relatively resilient, maintaining cap rates around 6.1%, slightly above larger multifamily properties. This premium reflects the higher perceived risk but also suggests ongoing investor appetite for multifamily assets, particularly in areas with stable occupancy and manageable operating expenses
In the coming months, multifamily investors will need to balance these dynamics carefully. While higher cap rates could mean better yields on paper, rising financing costs and compressed rent growth put pressure on deal structures. As we move into 2024, it’s clear that understanding the complex relationship between cap rates, Treasury yields, and other economic drivers will be key to navigating this ever-changing landscape.
