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Getting Creative with Cap Rates

May 1, 2024, 11:45 AM by Matt Mowell

Gauging how commercial real estate prices are faring is difficult during periods of volatility and limited liquidity. However, CBRE Econometric Advisors recently explored four alternative approaches to estimating property yields:

  • The Spread-Implied Cap Rate adds the average historical spread of cap rates over the 10-year Treasury to the current property yield.
  • The Fair Value Cap Rate estimates property yields based on the Gordon Growth model [risk-free rate + risk premium) - expected income growth].
  • The Debt Service Coverage Ratio (DSCR) Implied Cap Rate calculates the yield needed to pencil out a DSCR.
  • The REIT-Implied Cap Rate estimates property yields by comparing the relationship between current REIT share prices and a property’s expected income.

Figure 1 shows how each approach compares with traditional appraisal-based cap rate estimates. This comparison suggests the following:

  • Office cap rates may have more room to rise.
  • The rise in industrial cap rates may have peaked. (Notably, the spread-implied rate is markedly higher than the yields computed using other methodologies, likely due to the recent boom in capital flows into industrial.)
  • Current fair-value cap rates are low for retail, implying the sector may enjoy some downward pressure on yields.
  • Signals for the multifamily market are mixed, hinting that the outlook for pricing can vary depending upon market and asset selection.

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