Are Cap Rates Secure?
The years of high returns from rapid cap rate/yield compression may have passed, but a period of heavy cap rate/yield decompression is unlikely. We are not saying that cap rates/yields will be completely stable. We made it clear in the section above that they will respond to rent-growth expectations and other factors.
However, it is real long-term interest rates that matter for the long-term determination of cap rates or yields. The increases depicted in Figure 1 suggest some potential upward pressure on cap rates/yields over the next 10 years, but not by a large amount over such a long time.
There are other factors to consider. Institutional investors, who are loaded up on bonds, may struggle to meet retirement-income requirements in a period of sustained low real interest rates. As is now widely recognized, real estate is part of the solution. We expect, therefore, a long-term structural compression of spreads to accommodate the mild increase in interest rates.
It is unlikely that the cycle in cap rates will ever disappear, but there are good reasons to believe that there have been structural changes to the level of real interest and cap rates that are not going away in the foreseeable future.
"It is real long-term interest rates that matter for the long-term determination of cap rates or yields."
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