RERC, a SitusAMC company, finds that the decreasing Treasury rate in 2Q 2019 and an increase in CRE cap and discount rates led to a widening of spreads. The spread between the 10-year Treasury and the national overall CRE required pre-tax yield rate (also known as internal rate of return or IRR), going-in cap rate and terminal cap rate all increased by about 40 basis points (bps) quarter over quarter (QoQ). IRR yield spreads are the largest in almost two years.
This trend is explored in the August 2019 RERC Real Estate Report, “Sifting Through the Chaos.”
For the majority of property types, required IRRs increased. Industrial warehouse, neighborhood/community centers and hotel IRRs remained the same QoQ; no IRRs decreased. Hotel and industrial flex had the highest IRRs among all property types in 2Q 2019. Power center had the largest quarterly increase in IRR at 30 bps, showing the increased risk in the sector. Industrial warehouse had the lowest IRR among the property types. The past two quarters’ warehouse IRRs were tied for the lowest rates since 1989 when RERC began collecting these data. National overall CRE IRRs have remained consistent over the past few years and are among the lowest rates in the 30 years of historical RERC data.
A greater number of property types experienced increases in required going-in cap rates rather than decreases. Industrial flex and power center had the largest increases QoQ at 40 bps and 30 bps, respectively. The industrial warehouse going-in cap rate decreased by 30 bps QoQ in 2Q 2019, to its lowest rate since RERC began collecting these data in 1989 and continuing a general downward trend that began in 2010. Industrial warehouse and apartment tied for the lowest going-in cap rate in 2Q 2019, marking the first time since 4Q 2000 that the apartment sector did not solely have the lowest going-in rate. The national overall CRE going-in cap rate was steady QoQ, as it has been for the last three quarters.
The required terminal cap rate increased for the majority of property types in 2Q 2019. The largest jumps were in the industrial flex and power center sectors. Industrial warehouse, industrial R&D and apartment were the only sectors that had a decrease in terminal rates. The apartment sector had the lowest terminal rate, as has been the case every quarter for nearly 11 years. The national overall CRE terminal rate increased by 10 bps QoQ, and has been relatively stable for the past five years.
Expected rental growth for industrial flex declined by 30 bps in 2Q 2019, the largest decrease of any property type. Flex was tied with regional mall for the lowest average rental growth rate among the property types. Rental growth is expected to increase substantially for the student housing sector. The rental growth rate also increased for all three retail subtypes. Expense growth was little changed QoQ across most property types, and expense growth remained relatively consistent across property types. The largest declines in expense growth were in the hotel and power center sectors, and the largest increase in expense rates was in the suburban office sector.
The RERC Real Estate Report is the commercial real estate industry’s most respected and relied-upon survey-based resource of CRE investment criteria for risk analysis for over 45 years. This quarterly report is packed with a variety of valuation metrics, including cap rates, pre-tax yield/discount rates, and investor insights on the institutional, regional, and 47 major markets.
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