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An Inverted Yield Curve Underscores Stability, Opportunity In CRE

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An Inverted Yield Curve Underscores Stability, Opportunity In CRE

Alarm bells rang out in banks and bond markets a few weeks ago when interest rates for 10-year Treasury bonds dipped even further below rates for three-month bonds. But that same economic phenomenon, known as an inverted yield curve, may give real estate investors reason to sleep more soundly.

new report from Marcus & Millichap details how volatility in bond markets underscores stability and the strong returns in the real estate market. With the spread growing between bond yield rates and real estate capitalization rates, real estate could become an even more attractive place for investors to park their money.

When the yield curve inverts, it typically signals that investors have lost faith in the economy in the short term. Indeed, every major recession in the last century has been closely preceded by an inverted yield curve.

With the yield for long-term bonds falling to record lows, the yield on real estate is looking particularly strong in comparison. The yield on 10-year Treasury bonds fell to 1.54% in August. Meanwhile, the average cap rate for commercial real estate currently sits at 6.3%. 

“That spread is as wide as I can remember,” Marcus & Millichap’s Daniel Greenblatt said. “With bonds yields as low as they are and with rates on debt as low as they are, this could be a very good time to make moves in real estate.”

Greenblatt cautioned that real estate is by no means a “safer” investment vehicle than a bond just because it offers a greater yield. In fact, the higher cap rate is really a built-in premium for taking increased risk. It would also be foolish to forget that it was a crash in the real estate market that precipitated the world’s last major recession.

But in core markets, a high-end asset could be just about as safe as an investment in many bonds, especially if an investor can lock in a low interest rate from the current bull market. 

“In those safer, A-plus markets, a Class-A multifamily building is about as close to the risk level of a Treasury bond as you can get,” he said. “Those assets are going to weather the storm.”

An Inverted Yield Curve Underscores Stability, Opportunity In CRE
A graph tracking the spread between the average real estate cap rate in blue and the 10-year Treasury bond yield rate in yellow

Overall, Greenblatt has not seen many of his clients change their behavior as a direct result of the inverted yield curve, but some are taking more defensive positions as they see the clouds of a recession gathering overhead.

Some of his clients are working to establish debt funds, which offer less risk exposure than equity investments, though he said that the debt space is very crowded at the moment. Others are taking defensive financial positions by purchasing assets in core markets and keeping more cash on hand.

Some real estate investors are looking forward to the opportunities afforded by a general downturn. Valuations have been somewhat propped up by the current economic boom, Greenblatt said, and a slight economic downturn could knock between 5% and 10% off a building’s sticker price, making it an attractive purchase for an investor with a pool of cash.

“A lot of buyers have been sitting on the sidelines waiting for prices to come down,” he said. “They’re licking their chops and are ready to pounce.”

The next recession may not be as dire as many investors have made it out to be, Greenblatt said. It could simply involve two consecutive quarters of negative growth, the bare minimum definition for a recession, he said, and it does not necessarily have to be as drawn out and crushing as the most recent recession.

The fear of an economic downturn is also not necessarily the largest concern on real estate investors’ minds. In Greenblatt’s home market of New York City, he said, owners and investors were much more preoccupied with the recent rent stabilization laws. But they also felt that with interest rates so low, now is still a good time to make real estate deals.

“The biggest macro trend is interest rates dropping,” Greenblatt said. “Cap rates haven’t quite followed the way they typically do. More buyers could jump in and the spread will start to narrow, but right now, things are looking up.”

This feature was produced in collaboration between Bisnow Branded Content and Marcus & Millichap. Bisnow news staff was not involved in the production of this content.