RENT Magazine Q3 '21

During this century, apartments have benefited from this

a property purchased with 50% leverage may produce 50 bps lower annual cash flow than the same property acquired last year since cap rates have held firm while interest rates have crept up. Sellers today are receiving top dollar for their properties despite an uptick in the cost of borrowing for their buyers. Yet, there comes a point when increasing interest rates must force a rise in cap rates. Theoretically, the spread between Treasuries and properties should not drop to zero.

Otherwise, why would you invest in real estate when you can get the same yield —with less risk—from a government bond? Of course, real estate is not just about current cash flow, but the opportunity for appreciation tomorrow must be high to ignore the risks of ownership today. We believe it is reasonable to expect looming inflation to drive interest rates up over the next five years. Unless spreads for apartments achieve and maintain historically low levels, it is also reasonable to expect interest rates to nudge cap rates upward.

phenomenon more than retail, office or industrial sectors. So, what should we expect from apartments going forward? I wish I had a crystal ball, but we do have some macro- economic tea leaves to read. #1 Interest Rates Changes Cap rates do not move in lockstep with interest rates. The other two factors below explain variations in the metric known as the “yield spread” or simply, the “spread”—the difference at any time between a particular cap rate and the 10-year Treasury. Over the last seven years, the average national yield spread for apartments has ranged between 250 and 400 basis points (bps). If the Treasury yield is 2.00% and a given spread is 350 bps, the resulting cap rate is 5.50%, for example. During the last several months, we have seen spreads tighten among class-A apartments. Today P A G E 4 8 | 1

Urban Land Institute 1.

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