Thursday, August 28, 2008

Do Cap Rates Tie Into Treasury Rates?

In a "normal" real estate market, capitalization rates, or cap rates, will typically drop as interest rates drop, and go up as interest rates rise. Remember that cap rates represent the return that a buyer of an income producing property will earn on their investment. If rates drop, then the spread between "risk free" investment returns (aka Treasuries) and the various commercial property types should stay the same, therefore lower cap rates. The opposite is also true, that if Treasury rates rise cap rates should as well. This of course takes into consideration that the cap rates of some markets will rise, fall or stay the same for other reasons as well, such as regional considerations, improving or deteriorating property characteristics (e.g. lodging) or deteriorating or improving area economics.

Now, however, due to shift in the risk profile and real and perceived riskiness of certain asset classes, a drop in treasury rates will not necessarily translate into a drop in cap rates or commercial mortgage rates. Sometimes it will, and sometimes not. Research developed by RealtyRates.com gives some examples. As always, real estate is local, so it is critical that we do our homework, whether an investor or broker, so that we know what the real story for our particular area is. The chart can be viewed at http://www.realtyrates.com/commentaryg.html .

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