![]() ![]() Location: Proximity to the city’s employment center, highways and public transit also influences cap rates.“If we think things are overbuilt or there’s going to be a recession in the near future, BBB credit spreads tend to widen, which would drive cap rate spreads higher above the 10-year Treasury rate.” BBB spreads: “These investment bonds really measure the perception of credit risk of the market,” Gilbert said.But remember: Cap rates are typically forward-looking, and individual deals are affected by a building’s unique prospects and an investor’s viewpoint-as well as the prevailing economic conditions and outlook. When GDP is low and unemployment is high, there’s a greater risk associated with investment properties. When GDP is high and unemployment is low, commercial real estate investments tend to have lower cap rates. Gross Domestic Product (GDP) and unemployment: Both GDP and unemployment reflect the health of the economy.It remains to be seen if the pause is temporary or the start of a reactionary trend to a slowing economy engineered by Fed interest rat Rent growth: Rent growth can accelerate during periods of higher inflation, particularly in apartments with short-term leases. The anticipation of higher rents and greater NOI can offset higher interest rates. Likewise, deteriorating economic conditions can add upward pressure on cap rates and slow rent growth. “Through the second quarter of 2022, apartment and industrial rent growth has been strong, allowing cap rates to remain relatively stable in the face of rising interest rates,” Gilbert said. “More recently, rent growth has slowed. ![]() Interest rates aren’t the only economic element influencing cap rates. How other macroeconomic factors affect cap rates “While cap rates and interest rates are loosely correlated, and rapidly rising interest rates would generally imply upward pressure on cap rates, the change in cap rates would typically be mitigated by rent growth prospects, local economic outlook, neighborhood demand/supply balance and other idiosyncratic factors for a specific property or investor,” Gilbert said. But according to First American’s 2022 Q1 Potential Capitalization Rate (PCR) Model update, that is changing due to decelerating price growth and continued interest rate increases, both putting upward pressure on cap rates in the second and third quarter of 2022. Rather than mirroring interest rates, cap rates have remained stubborn, especially for multifamily and industrial properties. In recent months, the relationship between interest rates and cap rates hasn’t followed a 1:1 relationship. For example, if a building’s cap rate is 4.3%, it may only rise to 4.6%, depending on economic conditions and the property supply and demand balance in a given market. Cap rates tend to have a narrower range than interest rates, particularly over the short term, Gilbert said. High inflation and the corresponding interest rate hikes can impact commercial real estate cap rates-as interest rates rise, so do cap rates. The impact of interest rates on cap rates
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