Cap Rates Holding Fast, Analyst Says
11/21/2013 | by Allen Kenney

Andrew McCulloch, managing director with Green Street Advisors, joined for a video interview at REITWorld 2013: NAREIT’s Annual Convention for All Things REIT at the San Francisco Marriott Marquis.

McCulloch was asked about the impact of current interest-rate policy on private market property valuations.

“I think it would surprise most people, but since the upticks in rates in late May, private market property values haven’t moved that much,” he said. “Cap rates have been pretty steady. We all know that cap rates and interest rates are correlated, so it’s no surprise that real estate investors would get a little bit spooked when rates started to tick up.”

Such concerns are “overblown,” according to McCulloch.

“Prior to rates rising, return expectations for real estate had really become decoupled from the appropriate fixed-income benchmarks,” he said. “The spread between return expectations for real estate and fixed income had become abnormally wide. What that means is that private market real estate investors and real estate lenders had pushed cap rates down, but they stopped pushing cap rates down as interest rates continued to fall. Really what that created was a cushion or shock absorber. That cushion ignored the initial rise in rates that we’ve seen. That’s why cap rates haven’t moved that much.”

McCulloch also discussed the potential outcomes if interest rates continue to climb.

“Now that the cushion is gone, real estate looks fairly valued today,” he said. “If rates do continue to rise, now that the cushion is gone, it’s probably going to be bad for private market asset values. I think how bad depends on why rates are rising. If rates start to go up because the economy is getting better and you’re getting some inflation, then landlords are able to push that inflation through via higher rents. Those higher rents will offset higher cap rates, to some extent.”

McCulloch said trends in the listed real estate market are sending signals about the direction of the private market.

“The public market over time has been a pretty good predictor of future private market asset values,” he said. “It’s really why all real estate investors, whether they’re invested in public securities or direct real estate, should really be paying attention to what the public market is telling us.”