When the Federal Reserve lowers interest rates, it can have a noticeable effect on real estate cap rates, as long-term yields are a key factor in real estate investment decisions.

Sensitivity of Cap Rates to Interest Rates

Research from CBRE Econometric Advisors (CBRE EA) indicates that real estate cap rates respond differently to changes in the 10-year Treasury yield. Historically, for every 100-basis-point shift in the Treasury yield, cap rates adjust accordingly.

Impact on Industrial Assets

Industrial real estate has shown a lower sensitivity to interest rate fluctuations, driven largely by the surge in demand for logistics space following the COVID-19 pandemic. Prior to 2010, industrial properties were not as sought after, resulting in less cap rate compression. However, the rise of e-commerce and demand for logistics has increased net operating income (NOI) in this sector, helping cap rates remain relatively stable.

Cap Rate Outlook

CBRE anticipates that the U.S. economy will avoid a recession as inflation trends downward toward the Federal Reserve’s 2% target. With Treasury yields expected to remain below 4% through 2024 and dip to the mid-3% range in 2025, lower borrowing costs are likely to place downward pressure on cap rates. Additionally, robust fundamentals in most real estate sectors—excluding office—will drive rent growth and support further cap rate compression.

Key Takeaway

While cap rates are expected to compress gradually, they are unlikely to return to their pre-pandemic lows. Investors should consider broader macroeconomic factors such as inflation and GDP growth when evaluating opportunities and be cautious about certain markets and asset types, particularly the struggling office sector.