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Those following commercial real estate may find this article interesting !
Essentially is argues that CAP rates are about 400 basis points above treasury yields which is a historic high, thus indicating an "oversold" market condition.
Excerpts:
The cap rate spread over the 10-year Treasury yield is normally positive, reflecting the additional risks inherent in real estate assets (Exhibit 1). The risk premium is generally considered necessary to compensate for liquidity, leasing and tenant credit risk.
This risk premium component fluctuates depending on the outlook for the commercial real estate market. We believe this spread can serve as a rough gauge of the relative value of the real estate market.
When projected future income growth is strong, asset values will likely appreciate and the risk premium will decrease. As a result, the cap rate spread over the Treasury yield may fall below the long-term average.
For example, in 2005 and 2006 cap rates for several large office sales in Manhattan were reported to be less than 4%, well below the 10-year Treasury yield of about 5% at that time. Such low cap rates were justified at the time by expectations of significant income growth — often double-digit growth — in future years. Unfortunately, those aggressive assumptions did not materialize as the economy went into a severe recession in 2008 and 2009.
Conversely, when projected future income growth is weak, the risk premium will likely increase and the cap rate spread over Treasuries rises above the long-term average. Today, rents in most markets across the country are falling and asset values are depreciating. The risk premium is high.
As illustrated in Exhibit 2, the long-term average spread between the cap rate and the 10-Year Treasury yield since 2001 has been 320 basis points (the dotted line). We believe that persistently high cap rate spreads above the mean may indicate that markets are oversold, while persistently low cap rates — especially negative spreads to Treasuries — may indicate that markets are overbought.
more:
http://nreionline.com/finance/news/david_lynn_cap_rate_spreads_1005/ ://http://nreionline.com/finance/news/..._spreads_1005/ ://http://nreionline.com/finance/news/..._spreads_1005/
Note, this is a US view .. but an indication of a severe market correction (or as Don Campbell would call it: a pendulum swing to the other side) indicating BUYING opportunity !!
Essentially is argues that CAP rates are about 400 basis points above treasury yields which is a historic high, thus indicating an "oversold" market condition.
Excerpts:
The cap rate spread over the 10-year Treasury yield is normally positive, reflecting the additional risks inherent in real estate assets (Exhibit 1). The risk premium is generally considered necessary to compensate for liquidity, leasing and tenant credit risk.
This risk premium component fluctuates depending on the outlook for the commercial real estate market. We believe this spread can serve as a rough gauge of the relative value of the real estate market.
When projected future income growth is strong, asset values will likely appreciate and the risk premium will decrease. As a result, the cap rate spread over the Treasury yield may fall below the long-term average.
For example, in 2005 and 2006 cap rates for several large office sales in Manhattan were reported to be less than 4%, well below the 10-year Treasury yield of about 5% at that time. Such low cap rates were justified at the time by expectations of significant income growth — often double-digit growth — in future years. Unfortunately, those aggressive assumptions did not materialize as the economy went into a severe recession in 2008 and 2009.
Conversely, when projected future income growth is weak, the risk premium will likely increase and the cap rate spread over Treasuries rises above the long-term average. Today, rents in most markets across the country are falling and asset values are depreciating. The risk premium is high.
As illustrated in Exhibit 2, the long-term average spread between the cap rate and the 10-Year Treasury yield since 2001 has been 320 basis points (the dotted line). We believe that persistently high cap rate spreads above the mean may indicate that markets are oversold, while persistently low cap rates — especially negative spreads to Treasuries — may indicate that markets are overbought.
more:
http://nreionline.com/finance/news/david_lynn_cap_rate_spreads_1005/ ://http://nreionline.com/finance/news/..._spreads_1005/ ://http://nreionline.com/finance/news/..._spreads_1005/
Note, this is a US view .. but an indication of a severe market correction (or as Don Campbell would call it: a pendulum swing to the other side) indicating BUYING opportunity !!
