Cap Rates post-COVID

The 2008 recession precipitated the longest bull run in US equities. COVID has pushed governments to increase public spending and broadened the scope of what the market sees as acceptable (read: required) behaviour. Interest rates are not in free fall, but they are clearly dropping and/or at historic lows worldwide. But everyone knows these things. My question is: what do you guys think will happen with cap rates?

IMO, I think we're going to see a compression in certain asset classes (for example rental), as pension funds & large megacorp's that measure their performance largely in terms of dividend $ & yield look for steady income / returns. I've already heard rumors about cap rates on downtown rental bldgs at sub-3%. I think the influx of cash on everyone's balance sheet is going to push what we consider to "make sense".

  • Condo's and/or Townhouses I think will be driven less and less by job numbers, and instead, by quality of life in the city/area. As life gets back to "normal", I could see bigger companies move towards having permanent flexible work policies (some days in the office, some days at a WeWork desk, some days at home), leading people to re-evaluate their CoL and adjust where they live accordingly. Who wants a 400 sf studio?

  • I do question B & C class office performance.

  • I think anytime you start to talk industrial, everyone assumes it'll be Amazon that takes your +50,000 SF warehouse which doesn't feel like an honest conversation. So location, build quality, and market saturation are big factors for me.

  • Retail I wouldn't touch with a 10ft pole not because I think it's going to disappear, but I'd hate to try to time the bounce back for that asset.

  • Hotel: right now its the captain with the brown pants. I think inevitably will return, but again timing that seems stressful.

Comments (7)

Nov 10, 2020 - 6:22pm
IRR20ROC6, what's your opinion? Comment below:

Is the cap rate going lower due to a lower rent (income) in the Covid world, or a higher price?

Say if the property was traded right before Covid, would it be at a higher price? E.g. if income has since had a 20% discount while the price had a 10% discount, the cap rate will be lower.

I don't think it's a fair comparison if the new cap rate is purely calculated with a Covid rent, as everyone knows that it was a short-term thing, unless it was distressed.

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  • Investment Analyst in PE - Other
Nov 11, 2020 - 8:33am

cap rates are so low right now for 2 reasons: interests rates are the closest to zero they'll ever get and the stock market never had a crash so large money managers never rebalanced their portfolios away from REPE/RE Asset Managers. Real estate is flooded with money which is why you aren't seeing hotels sell for $0.40 on the dollar they're more like $0.90-$0.80.

Additionally, its currently possible to buy something at a 4 and still get some yield post debt service. Interest rates will go up per the new fed mandate and cap rates will follow suit over the next 2-5 years

Nov 11, 2020 - 9:59am
CRE, what's your opinion? Comment below:

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