Falling yields on investment-grade bonds are bolstering the case for real estate as an attractive investment, despite current market challenges. A recent report from Colliers found that cap rate spreads to BBB-rated bonds have fallen by nearly one percentage point below their historical averages across all asset classes. This decline in spreads, along with the relative stability of cap rates in the second quarter, is making commercial real estate a more appealing risk-adjusted option than low-end investment-grade bonds.

Investors use the spread between cap rates in commercial real estate and BBB-rated bond yields to gauge which asset class offers better risk-adjusted returns. Commercial properties with tenants and BBB-rated bonds both carry default risk, allowing for a comparison of their risk profiles. However, price discovery is simpler for fixed-income assets, which trade more frequently in open markets than commercial real estate. A wider spread suggests real estate is priced for higher risk-adjusted returns, while a narrowing gap may indicate that bonds are viewed as safer or more desirable in the current market.

Colliers' research director for U.S. Capital Markets Aaron Jodka said investors should pay close attention to the spread between yield-producing assets like real estate and bonds as the Federal Reserve prepares to cut interest rates.