Miguel Jauregui

(212) 951-8402

miguel@besenassociates.com

 

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January 2017

What Does the Yield Curve Really Mean for Real Estate?

With so much talk about the steepening yield curve, many investors have been laser-focused on how a rise in the 10-year Treasury rate (commonly accepted as the risk-free rate) could trigger a rise in cap rates, and therefore a fall in real estate values.

 

To provide some perspective, on December 1, 2016, the 10-year Treasury rate hit 2.45%, resulting in an increase of 85 bps over the running two month period beginning September 30, 2016. Other things equal, the 85 bps increase in the risk-free rate should increase cap rates by 85 bps. For example, a property earning a $500K NOI priced at a 5% on September 30, 2016 would have lost $1.5M in value over that two month period. This is intuitive given that investors expect to be compensated equally for their risk. However investors must be cognizant of other variables in formulating their investment decisions in today’s environment.

 

Other factors to consider are capital and credit availability, inflation, supply-demand dynamics and the growth outlook. As for capital and credit availability, equity capital seems to be abundant as foreign money seems to flow to NYC as a safe haven market, however conventional credit is tightening and construction loans are almost non-existent. As for inflation, consider that real estate serves as a hedge against inflation in the form of increasing rent revenue, so in an inflationary environment real estate will be in greater demand. As for market supply, an investor must consider only “real” deals that are priced at or near market, seeing beyond the overwhelming amount of non-realistic deals out there. Investors agree that it’s rare to come across a “real” deal these days, and the few that are out there are getting aggressively chased by all-cash transactions. As such, most investors would agree that supply is low and demand is high. As for the growth outlook, an investor must consider the opportunity of an expanding market where potentially a rise in rent revenue could outpace the rise in cap rates, which in today’s NYC market is tough to make sense of.

 

No one can time the market with absolute certainty, however taking into account the aforementioned, an investor could more confidently make the right buy and sell decisions. One thing is certain though, and that is that purchasing real estate at a cap rate near or below the risk-free rate is not sustainable. A wise man once told me that no one gets into real estate to lose money!

 

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