November 25, 2019
Cap Rates vs Interest Rates: The Effects on Value?
by David C. Chatfield • Multi-Family Investment Broker
Nearing the end of the second quarter of 2019, Capitalization Rates continue to favor sellers in the multifamily asset class and across most other product types. Are they going to increase as interest rates rise? Although the relationship is not a one to one, there is a correlation and there are additional factors that must be considered. Outside of property type, cash flow, age and location, real estate values can fluctuate based on market forces such as inflation and deflation, supply and demand, lending structures, changes in the capital markets, the local and national economy and governmental influence. In the second and third quarters of 2018 when the ten-year treasury rate crested the three-point mark, interest rates followed pushing ten-year money into the 4.75 – 5.00 percent range.
When looking at the US Economy, the US 10 Year Treasury Rate is an important indicator because Investors use this “risk-free” rate in helping to value assets and markets. In the short-term, as the Treasury yield rises, lenders can and will reduce their spread to stay competitive. Banks have the ability to determine the interest rate they charge for loans, but taking into account competition and Fed policies is part of that process. The 10-year treasury hit a historical high in 1981 at 15.84 percent and a historical low in 2011 at 1.37 percent. As of May 20, 2019, the rate remains extremely favorable to investors at 2.39 percent with 10-year money fixed at under 4.00 percent. With the Fed Funds Rate expected to stay in the mid two-percent range through 2021, buyers and sellers alike will benefit from the low cost of debt and competitive purchasing environment.
Local investors here in Oregon and southwest Washington have been questioning the higher prices and lower rates of return compared to previous holding periods, even though low-interest rates have accelerated refinances; this helps assets to cash flow better in a low cap rate environment. Prices here are still lower than other large markets on the west coast such as Seattle, San Francisco and Los Angeles. Out of state investors see Oregon and southwest Washington as an attractive market to invest excess cash or on a 1031 tax-exchange which offers a higher return on investment and larger economies of scale.
In conclusion, Capitalization Rates and Interest Rates do not move in lock-step and values can often be determined by supply and demand with different investment strategies. On a local level, the lift on the state wide rent control ban and additional changes to the landlord-tenant law has made many investors concerned, and shifted their focus to other markets, mainly outside the City of Portland. Norris & Stevens manages and sells apartment buildings in over thirty markets outside of Portland. Through more than fifty years of legal, political and market changes, with our market experience, we can help develop a plan to maximize the potential of your multifamily investments. Give us a call to discuss your investment strategy or if you would like an opinion of value on your property.
Norris & Stevens, Inc., is one of the largest locally-owned, full-service commercial real estate brokerage firms in Oregon and SW Washington. A member of the TCN Worldwide network, the firm was founded in 1966 and currently employs approximately 75 professionals in investment sales, leasing and property management for office, industrial, retail, land and multi-family properties. The firm’s property management portfolio exceeds 5 million square feet of commercial space and over 9,000 apartment units.