REAL ESTATE NEWS

With a Federal Reserve interest rate cut on the table later this month, industry observers are speculating about whether cap rates will fall as a result.

According to John Chang, Marcus & Millichap’s chief intelligence and analytics officer, many investors believe interest rates strongly influence cap rates. Chang’s historical analysis found that the 10-year Treasury and cap rates move together to a limited degree. He pegged the correlation between the two metrics at 40%.

However, there are many instances where the 10-year Treasury was rising while cap rates were falling and vice versa. For example, apartment cap rates steadily fell from 2002 to 2006 while the 10-year Treasury rate was rising slowly. However, from 2006 to 2007, Treasury rates fell as cap rates rose.

Generally, both the 10-year Treasury and cap rates have been trending lower, and there is no clear sign of any definitive cause and effect relationship between the two, said Chang.

However, transaction velocity does have a strong inverse correlation with cap rates, he said. When more deals are being done, cap rates fall and as transaction velocity slows, cap rates rise. This trend holds true across apartments, retail, office and industrial.

Zeroing in again on apartments, there is a clear trend from 2002 through 2006 where transaction flow climbed and cap rates fell, followed by a decrease in transactions between 2007 and 2010 and a corresponding increase in cap rates. The cycle repeated between 2021 and 2024.

”A key thing to pay attention to here is that transaction velocity is starting to climb again,” said Chang. “Now you might wonder if investor activity is being driven by the interest rates, and we looked into that. Once again there was a correlation, but it's small. There was only a 30% correlation between interest rate movement and transaction activity.”

Interest rates have been a major factor in slowing investor activity over the past two years, and if interest rates fall in the coming months, it could spur a significant wave of capital to re-enter the CRE investment market, said Chang. This could cause cap rates to taper, but there is a lag between the movement of capital and the movement of cap rates, he said.

Several factors are aligning that could push transaction flow higher, including pent-up capital waiting to deploy, a high volume of maturities coming due, and new tax benefits that could add to momentum. An interest rate cut could be a tipping point, said Chang.

“Even if interest rates don't decline, I still believe that investors will be increasingly active in the latter part of 2025 and into 2026,” said Chang. “Within that context, I once again suggest that investors take a hard look at their portfolios and identify any assets they want to prune. Then that capital can be redeployed into properties and markets that may offer stronger returns.”

Source: GlobeSt/ALM