The FAST Take

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Relationship between Cap Rates vs. 10-Year Treasury?

09/12/2023

The initial query: What’s the relationship between real estate cap rates and interest rates?

We have been travelling the country to speak with financial advisors about our views on the macro environment and current conditions for private markets asset classes.

A curious advisor considering an initial investment into private real estate asked about how cap rates are related to interest rates over time. Was there any kind of correlation between them? And how should he be thinking about this asset class as rates rise and/or remain structurally higher?

FAST takeaway #1: cap rates have a low correlation to interest rates.

We believe it is helpful to start with the long-term time-series. The chart below plots from 1985 to present.

Cap Rates vs. 10-Year Treasury1
Line chart showing cap rates and 10 year treasury from 1985 to 2022

Visually, cap rates show a long-term trend downward alongside rates. However, there are periods of time where cap rates and treasuries moved inversely to each other (~2001-2009, 2020-today). In total, the long run correlation between the two has been low at 0.1.

The follow up query: what about if we look at this on a lag?

The advisor was quite surprised to see such a low correlation, and suspected many of his clients and colleagues would not have suspected this. In fact, he challenged us to look at the same data with some lags to see if the outcome changes at all.

FAST takeaway #2: it doesn’t make a difference to lag; correlations remain low.

While applying a 24mo lag on cap rates visually looks like a bit better fit, with the peaks and troughs aligning to interest rates a bit better (see chart), correlations remain low (and even negative… see correlation table).

Lagged Cap Rates vs. 10-Year Treasury1
Line chart showing cap rates versus 10 year treasury with 24-month lag from 1985 to 2022

Here are the correlations with those lags1:

Cap Rates
6mo Lag
Cap Rates
12mo Lag
Cap Rates
18mo Lag
Cap Rates
24mo Lag
-0.04-0.100.050.09
 
To summarize

The advisor’s takeaway and ours is that the relationship between cap rates and interest rates is much more complex and dynamic than many suspect. As we face an environment of rising / structurally higher rates, it is not a foregone conclusion that cap rates follow suit.

Interest rates are an important input into cap rates, particularly over the long-term…but not the only one. In the short run, other factors (such as NOI growth expectations, credit spreads, inflation regime, liquidity conditions, to name a few) also play a significant role and can drive divergences from simply rates themselves, resulting in a more nuanced opportunity than one might expect.

The Financial Advisor Solutions Team

Ares Wealth Management Solutions

Carlin Calcaterra

Managing Director, Financial Advisor Solutions Team

Brendan McCurdy

Managing Director, Financial Advisor Solutions Team

Ready to learn more?

AccessAres is your resource for education and information about the private markets. Talk to us to learn more about these important asset classes.

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AccessAres is the thought-leadership and educational division of Ares Wealth Management Solutions. The materials distributed by AccessAres are for informational purposes only and do not constitute investment advice or a recommendation to buy, sell or hold any security, investment strategy or market sector. Ares Wealth Management Solutions is a global brand of Ares Management Corporation.

You are now entering the AccessAres website

AccessAres is the thought-leadership and educational division of Ares Wealth Management Solutions. The materials distributed by AccessAres are for informational purposes only and do not constitute investment advice or a recommendation to buy, sell or hold any security, investment strategy or market sector. Ares Wealth Management Solutions is a global brand of Ares Management Corporation.

You are now leaving the AccessAres website

AccessAres is the thought-leadership and educational division of Ares Wealth Management Solutions. The materials distributed by AccessAres are for informational purposes only and do not constitute investment advice or a recommendation to buy, sell or hold any security, investment strategy or market sector. Ares Wealth Management Solutions is a global brand of Ares Management Corporation.