Whither Cap Rates? What 2012 Will Bring
There are three reasons why capitalization rates may be set to decline this year.
Leasing markets are improving, which means that a broader swath of properties will see effective rental rates increase as landlords pull back on concessions. National indexes for asking rental rates still are largely flat — with the exception of apartments — but many of the best properties in the best locations across all property sectors are seeing reduced concessions or outright rental rate increases. As the leasing market tightens in 2012, this pool of fortunate properties will expand to encompass assets that are slightly less impressive in terms of quality and location.
The wave of distressed assets has passed its peak. Real Capital Analytics notes that distressed assets peaked at $140 billion in 2009 before falling to $92 billion in 2010 and $56 billion in 2011. Real Capital says that the volume of distressed assets will be “material” in 2012, but clearly we are past the peak. Commercial real estate 30-day delinquency rates at banks also are headed lower, down to 6.69 percent in the third quarter of 2011 from the recent peak of 8.76 percent in the second quarter of 2010. Only CMBS delinquency rates appear to remain at or near the peak — 9.32 percent (60 days and up) in December according to Moody’s. Fewer distressed assets mean that buyers may begin to take an interest in the vast swath of middle-market properties lying between “trash” at one end and “trophy” at the other.
The spread between the average cap rate and the 10-year Treasury yield, at over 500 basis points, is as high as it has been in at least 10 years. The Federal Reserve has promised to keep interest rates low and monetary policy accommodative at least through 2013, and the tame outlook for inflation — even in the face of improving economic fundamentals — will provide the necessary cover for them to accomplish their goal. With interest rates low and stable, it looks like there is room for some further decline in cap rates.