'Moderate Bump' Expected For Cap Rates In Near Term

Cap rates will likely rise as interest rates tick up, possibly through next year, according to a new analysis from Moody’s Analytics.

While multifamily and industrial have held steady, cap rates in the so-called “lesser-performing” sectors of office, retail and hotel have reacted to rate hikes. But analysts at Moody’s do expect “some moderate bump” in cap rates across other property types in the near-term.

“There are strong opinions in the market both ways, that cap rates will go up significantly with rising rates, and others saying that cap rates will go down, and demand and expectations of rent growth will compress risk premiums,” said Kevin Fagan, head of CRE Economic Analysis for Moody’s Analytics. “We have taken a measured approach in our forecasting, trying to find a balance between demand for the sector with upward pressure from rates.”

The Moody’s report, written by Victor Calanog, Jun Chen, and Todd Metcalfe, says there is some room for the risk-free rate to rise before cap rates are pushed to increase. Multifamily, for example, has been aggressively priced with low cap rate: through March 15, about 10% of CMBS properties had cap rates of 4.5% or lower, of which 2.6% were at 3%—“significantly lower” than other property types, according to Moody’s.

“While these low cap rate multifamily properties may be some of the better performing assets on the income side, they are also the most likely to see rates rise because they lack cushion over the risk-free benchmark Treasury,” the report notes. “Essentially, sectors that have been transacting at very low cap rates have little place to go but up.”

Tightening monetary policy and the war in Ukraine, which is weighing on energy prices, have increased risk for global markets for the rest of this year, but Moody’s also says that so far, performance metrics on the income side for commercial real estate have been steady.  But “like single-family home prices responding to higher mortgage rates, we expect that the effect of higher uncertainty will manifest in volatility in CRE prices in the near-term,” the report says.

From a sector-specific viewpoint, Moody’s is maintaining a positive, “robust” outlook for the industrial sector, noting that “the prospects are so strong that industrial lease terms have begun to decline markedly.”  The economists note some headwinds, including the news that Amazon will be cutting back on warehouse space, but Moody’s calls that “a drop in the bucket” for the sector and says it’s not likely that third-party logistics providers would scale back significantly.

“We expect demand for this property type to remain strong in the near term,” the economists write. “Accordingly, compared to all other core sectors in commercial real estate, our rent growth forecasts for industrial are also the most robust.”

Moody’s says the hotel sector may catch a “much-needed break” if GDP growth remains positive this year, while the office and retail sectors are still catching up. Analysts emphasize, however, the extent to which the tech sector plays a role: those markets with a robust tech presence are showing office rents rising five times faster than the national average. And for retail, neighborhood and community centers are faring better than regional malls, though analysts say slumping consumer sentiment is weighing down the sector’s immediate prospects.