A reader asks: “Can capitalization rates go to zero?”
Well, no . . . but they can certainly get close. Case in point: look at the results of the third-quarter 2014 Real Estate Research Corporation survey of institutional investors and advisers—average cap rates are down 5 basis points—the 19th sequential decrease since the high-water mark that occurred during the fourth quarter of 2009/first quarter of 2010. And speaking of unchartered territory, we are also reaching heretofore unplumbed depths, with interest rates at their lowest levels since second-quarter or third-quarter 2007—the height of the prior unbridled enthusiasm.
Average Cap Rates According to the Real Estate Research Corporation
| Highest level | Lowest level | Current level – 3Q 2014 | |
| All-property index | 8.60% | 6.47% | 6.45% |
| Multifamily | 7.60% | 5.70% | 5.10% |
| Office: CBD | 8.00% | 6.00% | 5.70% |
| Office: suburban | 8.60% | 6.50% | 7.00% |
| Retail: mall | 8.40% | 6.40% | 5.90% |
| Retail: neighborhood | 8.70% | 6.50% | 6.80% |
| Retail: power | 8.60% | 6.40% | 6.50% |
| Industrial: warehouse | 8.50% | 6.30% | 6.00% |
| Industrial: R&D | 8.80% | 6.80% | 6.90% |
| Industrial: flex | 9.00% | 6.80% | 7.10% |
| Lodging | 10.40% | 7.20% | 7.50% |
We are now faced with a choice: either we go “risk on,” competing in the market on the market’s terms, i.e., justifying real estate pricing based on relative value compared with alternatives, and searching for yield in new markets (the secondary and tertiary ones) and in new sectors (student and seniors’ housing, medical office, and the like), all the while enjoying the “lowest-risk” premiums in memory.
Or, we go “risk off” and try to smile knowingly while sitting on the sidelines.
Not an easy choice as there is incredible pressure to invest—not at all costs, but invest nonetheless.
Monday’s Numbers
The Trepp survey for the week ending October 31, 2014, showed average spreads basically unchanged with the implied rate for ten-year, modestly leveraged commercial real estate mortgages equaling 3.93 percent—71 basis points lower than at year-end 2013. Our expectation is that nothing will change before year–end, with increases or decreases in spreads offset by comparable increases or decreases in ten-year Treasury bond yields.
Asking Spreads over U.S. Ten-Year Treasury Bonds in Basis Points | |||||||
12/31/10 | 12/31/11 | 12/31/12 | 12/31/13 | This week (10/31/14) | This week (10/24/14) | Month earlier | |
Office | 214 | 210 | 210 | 162 | 148 | 151 | 142 |
Retail | 207 | 207 | 192 | 160 | 142 | 144 | 133 |
Multifamily | 188 | 202 | 182 | 157 | 138 | 139 | 130 |
| Industrial | 201 | 205 | 191 | 159 | 142 | 144 | 132 |
| Average spread | 203 | 205 | 194 | 160 | 143 | 145 | 134 |
| 10-year Treasury | 3.29% | 2.88% | 1.64% | 3.04% | 2.50% | 2.29% | 2.42% |
The Cushman & Wakefield Equity, Debt, and Structured Finance Group’s monthly Capital Markets Update of commercial real estate mortgage spreads dated November 6, 2014, show no change in required spreads as compared with the prior survey period, confirming our suspicion that all everyone is thinking about and focusing on is getting this year’s deals closed as well as issuing commitments for first-quarter 2015 deals that have been in the pipeline for a while.
So long as event risk is off the table, everything remains right with the financial world.
30-Year Fixed-Rate Commercial Real Estate Mortgages (as of November 6, 2014) | |||
Property | Maximum loan-to-value | Class A | Class B/C |
| Multifamily (agency) | 75–80% | T +160 | T +170 |
| Multifamily (nonagency) | 70–75% | T +170 | T +165 |
| Anchored retail | 70–75% | T +185 | T +195 |
| Strip center | 65–70% | T +185 | T +195 |
| Distribution/warehouse | 65–70% | T +185 | T +195 |
| R&D/flex/industrial | 65–70% | T +190 | T +200 |
| Office | 65–75% | T +180 | T +190 |
| Full-service hotel | 55–65% | T +235 | T + 255 |
| Debt-service-coverage ratio assumed to be greater than 1.35 to 1. | |||
Year-to-Date Public Equity Capital Markets
Dow Jones Industrial Average: +6.02 percent
Standard & Poor’s 500 Stock Index: +9.93 percent
NASD Composite Index (NASDAQ): +10.92 percent
Russell 2000: +0.83 percent
Morgan Stanley U.S. REIT Index: +18.58 percent
Year-to-Date Global CMBS Issuance | ||
| 2014 | 2013 | |
| U.S. | $79.3 | $71.7 |
| Non-U.S. | 3.7 | 10.6 |
| Total | $83.0 | $82.3 |
| Source: Commercial Mortgage Alert. | ||
Year-to-Date U.S. Treasury Yields
U.S. Treasury Yields | |||
| 12/31/12 | 12/31/13 | 11/7/14 | |
| 3-month | 0.08% | 0.07% | 0.03% |
| 6-month | 0.12% | 0.10% | 0.06% |
| 2-year | 0.27% | 0.38% | 0.55% |
| 5-year | 0.76% | 1.75% | 1.67% |
| 7-year | 1.25% | 2.45% | 2.03% |
| 10-year | 1.86% | 3.04% | 2.38% |
