The Federal Reserve and recent capitalization rates - by John Rynne
Finally, the Federal Reserve is awakening to the calls from the White House to reduce interest rates. The Federal Reserve chairman, Jerome Powell, was hesitant to lower rates because of the fear of inflation. During 2022-23 inflation spiked substantially in all sectors after COVID when local, state and federal governments let loose trillions of dollars into the economy; some of which was ill advised. Also, there were some of the lowest interest rates in modern history during the previous 5-10 years. Some 4-5 years ago, there were home mortgages as low as 2.5% and many which were in 3-4% range. For large apartment complexes the rates were not as low but easily within 100 basis points. This also applied to long-term high credit commercial, offices and industrial properties. These low interest rates had an inflationary result on all categories of properties. This in conjunction with the exploding government COVID spending created the inflation problem which not only affected real estate but all other sectors. Currently, there is a hangover of residential especially single family real estate prices because potential sellers are reluctant to sell. They want to retain the low interest rate of a refinance or purchase money mortgage gotten in previous years.
This wasn’t as evident in the office market because of the high vacancy rates that has stubbornly stayed with that sector post COVID. Other than office, the supply of single-family residential, well-located retail and warehouse space is in short supply. As an example, MLS listings in some of the Upstate residential markets are down by 75% from their peak. This put constant pressure on inflation in the single family housing market where there are still bidding wars. In fact, in recent days there was a signed contract which was 50% more than the list price in a Rochester suburb. So Powell was hesitant to decrease rates on that basis alone. In addition, the unknown effect of the Trump administration tariff policy was also a factor, If the tariff policy failed it could be a major factor in the inflationary trends. However, because of low new job numbers, slightly increasing unemployment and stagnant low inflation rates the Federal Reserve reluctantly decreased interest rates with more on the horizon.
The 10 year treasury bill is one of the best indicators for mortgage loan interest rates which have a large impact on overall capitalization rates. Mortgage rates generally are 100-200 basis points over the treasury rate depending upon the quality of the loan. On January 13th the 10-year treasury was 4.79%. On March 30th the 10-year treasury was 4.48%. On September 26th the 10 year rate was 4.2%. and October 15th the 10-year treasury rate was 4.08% or 71 basis points lower than in mid January. Because of this, overall capitalization rates continue to slowly decrease. This has favorably affected all property categories; especially multi family, light industrial/warehouse and high quality credit tenant retail. Although, the interest rates have dropped significantly for multifamily, it has been a double-edged sword. Lower interest rates will spur more single family home purchases. This will decrease demand for rentals of apartments.
For functional light industrial/warehouse properties there has been extremely low vacancy because of increasing demand. Although, the tariff controversy has moderated this demand, it is still relatively vibrant. Well-located retail continues to be in high demand especially with regional, national or international credit tenants. Highly trafficked commercial sites have large demand for fast food, pharmacies, bedding/mattresses outlets, auto parts, etc. There are many such sites with overall capitalization rates in the general range of 5%-9% with the lower end cap rate being newer high quality credits with substantial time left on the lease. The higher end cap rate being older facilities, lesser financial credit tenants and not much time left on the lease. As an example, there is a Dollar General tenant located in North Syracuse which has a long-term absolute triple net lease with 5% increases every five years. The asking price is $2,415,252 which results in an overall capitalzation rate of 6.15%. The average overall rate for multifamily, light industrial, retail and Class A office is 6.5%, 8.5%, 8.5% and 7 %. respectively.
In summary, overall capitalization rates are declining which will have a positive effect on values. Feel free to visit our website which has five categories of office, three categories of retail, four categories of industrial, five categories of apartments, and six categories of special use real estate rates.
John Rynne, MAI, SRA, is president and owner of Rynne, Murphy & Associates, Inc., Rochester, N.Y.