Interest rates still stand at some of the lowest levels in one hundred years. As fear resides, greed surfaces. Investors are in a desperate search for yield. The article below explains that the market for office buildings is being powered primarily by low interest rates, which have made it cheap to borrow money and have made the income buildings generate from rent seem relatively appealing. “The world is starved for yield,” says Scott Rechler, chief executive of New York landlord RXR Realty LLC, one of New York City’s most-active recent buyers.
Interest rates drive cap rates as investors attempt to create positive yields between the property’s return and mortgage rates or returns on more passive investments. The chart below shows the relationship between cap rates, interest rates, and the spread between the two. Only during the whacky 80’s did spreads turn negative. In those times, all cash buyers dominated the market place and super high rent increases (or projected rent increases) were used to make those negative spreads disappear.
Cap rates are at the lowest point since 1951 except for their most recent lows during the peak years 2007/2008. Mortgage rates, on the other hand, are also at some of their historical lows despite their 100 basis point rise from the low of last year.
The question arises on whether cap rates and interest rates are both sustainable. Bill Gross argues that governments must maintain rates and will only very gradually raise them over a long period of time because economies are addicted to low rates. Any sudden rise would have a very harmful impact on the economy.
We must be aware that the cap rates and interest rates today are far from the norm.