Correlation Between Cap Rates and US Treasuries
The US Ten Year Treasury Bond (“ UST ”) is deemed to be the riskfree investment against which returns on other types of investments can be measured . Interest rates on UST have been on a broad decline for many years but have recently began to rise . There is now concern that as interest rates begin to rise , so will Cap Rates , and consequently there may be reduction in asset values over time ? With so many uncertainties in the market , and growth projections constantly being revised , the spread between UST and Cap Rates have not remained constant .
Also , the discussion of the above , effect of cap rates resulting from artificially low interest rates , inflationary expectations , and anticipated increased interest rates need to be discussed in another article . result in an increased Cap Rate . On a macro level , this could result in lowering all real estate prices .
How dramatic can lowered real estate prices be over time ? As we witnessed 10 years ago , the contagion effect could spread and result in dramatically lower values , and substantially increased Capitalizations Rates .
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Summary
Cap Rates are a good starting point in analyzing a property ’ s value , but they should not be the only analysis . It is prudent to look at the cashoncash return and the internal rate of return as well . Factors such as changes in NOI , vacancy rates , and changes in neighborhood property values are just a few other considerations . Also recognize that Cap Rates may vary widely in different geographic areas . Property appreciation , perhaps one of the greatest reasons for investing in real estate , is not part of the Cap Rate calculation . For investors , the tax benefits of owning commercial real estate may , in and of themselves , be the driving force to make such an investment . If the property is to be leveraged , then there may be writeoffs for loan fees , interest expense , depreciation and investment expenses . Taking all these factors into account can help achieve the basis for making a sound business decision .
As interest rates go up , will this automatically cause Cap Rates to rise , and values to go down ? Not necessarily in the short term . Remember that increased debt service based upon higher interest rates is not considered in the capitalization approach . But , over time as interest rates go up , borrowers will feel the sting of higher debt service payments . Some property transactions may become less appealing financially . As purchasers and borrowers elect not to purchase , that may compound and create more unsold inventory . Some sellers may get desperate and reduce price to sell quicker . The lowered price would
MEET DAN HARKEY
Dan Harkey is a business and private money financial consultant . He has been active in the real estate and financial services industry since 1972 . He has taught courses on private money lending and underwriting of commercial / industrial properties at over 350 educational seminars . This and many other articles he has written are available on his website , Danharkey . com .
You may also reach him at his office ( 949 ) 5217115 or by email at
dan @ danharkey . com . You can also find him on LinkedIn .
Dan J . Harkey Business and Private Money Lending Consultant Mobile : 949.533.8315 Office : 949.512.7115
dan @ danharkey . com
The article is for educational purposes only and is not intended as a solicitation
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