Commercial Real Estate: As long-term interest rates tumble, CRE yields become more attractive

The average real estate yield increased from 2Q 2019 to 3Q 2019, while both Moody’s Baa and Moody’s Aaa decreased during the same time period. This is causing the spreads between real estate yields and corporate yields to widen.

These are among the many preliminary results from the 3Q 2019 edition of the RERC Flash Report, which was released earlier this week.

After gradually raising short-term interest rates since December 2015, the Federal Reserve Board reversed course earlier this year, reducing the federal funds rate by 25 bps in July and September. The September fed funds rate was set at 1.75%-2.00%.

Citing global economic uncertainty, including worries about the U.S.’s continued trade war with China, and muted inflation as the rationale for its decision, the Fed believes that the rate cuts will lead to a sustained economic expansion and strong labor market. The Fed recently raised its economic growth forecast for 2019 from 2.1% to 2.2%.

The 10-Year Treasury rate has been trending downward since October 2018. This trend continues into 3Q 2019, with the first two months of the quarter averaging 1.8%. This is broadening the spreads of the real estate yield over the bond yield as well.

Analyzing survey data from institutional investors, RERC finds that the overall CRE market is perceived as riskier relative to returns in 3Q 2019 compared to the previous quarter. Among the property types, student housing was the only one to show an increase in its return vs. risk rating. For the 11th consecutive quarter, the value vs. price rating decreased for the overall CRE market, indicating that prices are increasingly outweighing values.

Most subtypes showed a decrease in investment conditions from 2Q 2019 to 3Q 2019, signaling a possible downturn of investor confidence. The industrial warehouse subtype continued to hold the highest rating in investment conditions among all property types.

We note that the RERC Flash Report presents only a preliminary look at our 3Q 2019 institutional investment survey data and reflects only the information drawn from surveys received to date. As additional investment survey data continue to come in, they will be integrated with current data and reported in the 3Q 2019 RERC Real Estate Report, set for release in late November.

To purchase your copy of the complete RERC Flash Report or to subscribe to the RERC Real Estate Report, visit store.rerc.com or call 319-352-1500.

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