Fundamental Cap Rate Question

I am graduating with a Real Estate Degree and am trying to keep up with real estate news and the market, so I'm still young have some trouble with general concepts. We are seeing record low cap rates and record high property prices, but at the same time I keep checking the 10 year treasury rate and because of inflation the number is increasing every day. Went from 1.5 to 1.8 this month and I was taught that the cap rate-10 year treasury spread stays consistent, so doesn't that mean that cap rates are due to increase and therefore prices need to drop and properties are overvalued. Would love some clarification, Thanks!

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Comments (4)

  • VP in RE - Comm
Jan 10, 2022 - 1:35pm

Historically there has been a correlation between cap rates and the 10 YR but that correlation is not strong. A stronger correlation actually exists with BBB corporate bond yields.

Regardless, what you are forgetting is that real estate is not liquid like bonds and treasuries, and the cap rate correlation can vary widely by asset type (residential, industrial, hotel). Additionally, unprecedented amounts of capital were committed to commercial real estate over the past 24 months, that capital will still need to be deployed. Of course there are limits, if interest rates rise high enough where financing a deal is actually negative arbitrage compared to the purchase cap rate, then you would see cap rate expansion. 

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Jan 10, 2022 - 1:32pm
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