More Research Shows Cap Rates Likely To Keep Compressing

Opinions are starting to pile up that commercial real estate will remain hot, prices will rise, and as a result cap rates fall. 

The National Association of Realtors released an analysis that said cap rates were likely to keep compressing in 2022 despite rising interest rates. 

Although typically rising interest rates would push up mortgage costs, creating downward pressure on property prices, that may not be the case, at least for now, because other factors keep pushing up prices and, in turn, further compress cap rates.

“As of 2022 Q1, office real estate prices are up 10% year-over-year on average while prices of retail real estate are up 16%. Industrial properties experienced the strongest price gain of 30% followed by apartment assets at 22%,” as the NAR noted.

Multifamily units as well as single-family rentals and build-to-rent units will see greater demand as higher mortgage rates and house prices expand the pool of people who are no longer able to buy a home. The greater the demand, the greater the potential rent, and investors are buying future rent rolls. 

NAR posited that reduced consumer spending “will tend to lower the demand for industrial space but increased demand for warehouse space to minimize supply disruptions (just-in-case inventory management) [and] could boost absorption.” However, in the most recent Bureau of Economic Analysis, consumer spending was still increasing, suggesting that demand for industrial hasn’t yet started on a downslide. Furthermore, sentiment for industrial brokers has fallen because of a lack of inventory, and tighter availability will also drive prices up and caps down.

Inflation would seem to eventually push down on consumer spending and retail demand, but as the organization said, “retail stores providing essential services like the neighborhood centers will do better than retail stores providing non-essential services like high-end shopping malls.” Presumably investment would shift to those areas, increasing prices. And as workers go back to the office, demand will see some upward pressure to offset slower business formation.

JLL recently saw similar mechanisms and thought that cap rates would continue to stay low. Interest rates are only one factor that affect cap rates. Other factors, like net operating income (improving with higher rents) and pure premium risk can act as offsetting pressures, pushing cap rates lower.

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