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CALCAP Connections September 2018
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The Complex Correlation Between Cap Rates and Interest Rates
Yesterday the Fed raised interest rates 0.25%, for a third time this year, and the eighth time since the 2008 financial crisis. Another increase is expected in December, citing "economic activity rising at a strong rate". As short-term interest rates continue to rise, the logical question is whether cap rates will rise in tandem?
The capitalization rate is a commercial real estate metric that measures a property's unlevered returns based on the net income the property expects to generate in the first year, divided by the price of the property. Cap rates have continued to remain at historically low levels, due to continued capital flows into the space. We have seen recent instances where cap rates are still declining, despite the Fed hikes. As seen in the chart below* (courtesy of John Sebree, Marcus and Millichap Research Services), there has been a positive correlation between apartment cap rates and the 10-year treasury going back to 1990. Spreads have been as wide as 450 basis points in 2012, and as narrow as 100 basis points in 2006.
While a correlation between interest rates and cap rates seems obvious, there are other factors at play that determine how much of a premium over the "risk free" 10-year treasury, investors will demand. Variables like availability of leverage, tax implications and general investor confidence all provide context to spread levels.
*Marcus and Millichap Research Services
Investor demand and availability of capital will continue to be the driving force that will determine where spreads go. If interest rates continue to rise, and investor capital retreats from the space, then an increase in cap rates would most likely be inevitable. If investor demand and capital remain constant or increase, then cap rates may compress further.
At CALCAP, our acquisition analysis always assumes cap rates will be higher (typically 50-100bps) when we exit the property. We feel this is conservative and prudent given the low cap rate environment we are currently experiencing. Only time will tell where cap rates go, and we are watching very closely.
Sincerely,
Edward M. Aloe
President and CEO
626-229-9057
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RealPage: Multifamily performance remains strong in Q3, elevated supply worries remain
As has been the case for some time now, the gap between affordable and high-end apartment performance is in full effect. Willett says much of the product on the way is in the high-end class and will put downward pressure on the class' rent growth, while moderate to affordable product will continue to soak up high levels of demand and maintain its momentum.
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Freddie Mac: September forecast indicates affordability continues to weaken growth
"The spring and summer home buying and selling season ultimately ended up being a letdown, despite a faster growing economy and healthy demand for buying a home," Freddie Mac Chief Economist Sam Khater said. "Unfortunately, too many would-be buyers continue to be tripped up by not enough affordable supply and the one-two punch of much higher home prices and mortgage rates."
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Zillow: The rent growth fever just broke
"Earlier this year, the housing market was a story of diverging paths, with rents steadily cooling and home values picking up speed. Normally rents and home values are tied together, but strong apartment construction and a surge of young homebuyers contributed to this historical anomaly. As summer turns to fall, the more typical pattern is reemerging, as rents and home values are both slowing in unison," Zillow Senior Economist Aaron Terrazas said in a statement.
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California Capital Real Estate Advisors, Inc. (CALCAP) is a real estate investment and advisory firm.
Partnering with businesses, asset managers, developers and communities we reposition distressed real estate, and provide liquidity, adding value for our stakeholders and the communities we serve.
We are proud of our ability to identify opportunities and to move quickly in adding value to a diversity of projects. Through our experience, extensive network and creative problem-solving skills we have established a strong record of success.
CALCAP's work includes the acquisition of distressed residential and commercial properties and debt; the repositioning of real estate; asset management; real estate brokerage; consulting; and real estate financing services.
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LOS ANGELES
The Sanborn House
65 N. Catalina Avenue
Pasadena, CA 91106
Edward M. Aloe, President & CEO
(626) 229-9057
Mark A. Mozilo, Principal
(626) 229-9056
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SAN DIEGO
12626 High Bluff Drive, Suite 360
San Diego, CA 92130
Patrick A. Wakeman, Principal
(858) 764-4890
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PHOENIX
4747 North 7th Street Suite 170
Phoenix, AZ 85014
Drew Buccino, COO
(602) 419-3381
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SANTA BARBARA
1309 State Street Suite A
Santa Barbara, CA 93101
Greg Blix
Director of Investor Relations
(805) 896-8500
greg.blix@calcapadvisors.com
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IRVINE
2603 Main Street, Suite 850
Irvine, CA 92614
Len Israel
CEO, CALCAP Lending, LLC
949-439-1044
len.israel@calcapfinancial.com
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