Conventional wisdom tells us that cap rates and bond yields have a one-to-one relationship, and many investors use this supposed relationship to inform decision-making, especially in a rising bond yield environment like today.
But is this correct? And how has it been impacted post Global Financial Crisis, which put stress on the global financial markets and had an extreme impact on commercial real estate?
Curious, and in the interest of better serving clients, Berkadia Research set out to examine this axiom to better understand the relationship between bond yields and cap rates and what we found was surprising.
The truth is, the correlation between bond yields and cap rates varies over time. In fact, historically and post-GFC, bond yields and cap rates do not have a 1:1 relationship and moving through time their relationship varies considerably. It’s unwise, and potentially risky, to assume rising bond yields imply rising cap rates.
But this doesn’t mean there aren’t any market factors that can give us insight into cap rate movement. What our analysis shows is that we need to think more broadly: the post-GFC era can be characterized by unemployment, the nominal Treasury yield, global apartment volume, domestic volume, and effective rent moving up in rank as drivers of cap rates.
And it’s true that cap rates have momentum. We confirmed and quantified the assumption that past cap rates are indicators of future cap rates. Last quarter’s cap rate is 98 percent correlated with this quarter’s cap rate.
The GFC cannot be overlooked in how it has impacted cap rate drivers —post GFC, domestic volume drives cap rates more than total volume, and global volume drives cap rates more than cross-border volume. And the real unemployment (U-6) is a stronger driver of cap rates than the unemployment rate mentioned in the news (U-3).
Above all, what we’ve determined is that market relationships with cap rates are complex, but they can give us powerful insight. From macroeconomic data to apartment fundamentals, every metric plays a role in the interconnected space of multifamily real estate.
Want to learn more? Read our most recent whitepaper, Quantifying Market Relationships with National Cap Rates, for a full analysis of the market factors driving cap rates and which to track to make the most informed investment decisions.