Santa's Special Delivery: Unwrapping High Cap Rates

The past few months have been a whirlwind for interest rate changes; The 10-Year Treasury peaked at 5.0% during mid-October; however, the yield recently receded back to early September levels of around 4.3%. These fluctuations, amounting to a 70-basis-point change, are not indicative of a normalized market, leaving real estate lenders in a state of uncertainty and caution.

Many lenders have opted to stay on the sidelines, while those still active have widened their spreads. These lenders have elevated interest rates beyond 7.25% for comparable products, in contrast to our recently closed Kentucky portfolio, which secured a 6.22% rate this summer. For many investors, this rapid increase diminishes confidence on the direction of the real estate market; these investors are refraining from transacting until stability returns to daily interest rate changes.

For proactive investors, this is a very small window to acquire properties that are forced to be sold during this period. These properties are being listed with Cap Rates pushed 100 basis points (1%) higher than prior quarters. At this point, most Sellers will chose to delay disposing their properties, waiting for the rates to come back down, while others are forced to sell at these higher Cap Rates due to loans maturing and other economic considerations. 

Industrial Single-Tenant Transaction Trend Analysis

Our team conducted an analysis of recently transacted single-tenant NNN industrial deals in the states surrounding our Southeast investments. The findings reveal that, in the past six months, Cap Rates across 16 deals ranged from 6.4% to 9.6%, with an average Cap Rate of 7.22%. These deals had an average lease term remaining of around 6.1 years. In comparison, the previous six month period's 21 transactions showed a Cap Rate range of 5.4% to 9.0%, with an average Cap Rate of 6.98%. These transactions had an average lease term remaining of 12 years, which was almost double the current period's average and can heavily affect average Cap Rates. Not only has the transaction volume decrease by over 20%, even with the holiday season's effect on the previous period, but the average Cap Rate also increased by 24 basis points (0.24%).

Taking a look at single-tenant industrial transactions over the past two years in the Southeast/Central Northeast shows the average Cap Rate reached its minimum of 6.12% in Q2 of 2022 and has grown substantially since then, which correlates with rising rates and additional factors discussed in the previous LWP Newsletter. Current lack of on-market supply and interest rate decreases should initiate Cap Rate decreases once again, if they have not begun decreasing already.

For the investors that are fortunate to close in this period of higher Cap Rates, they will undoubtedly place short term and refinance when rates recede in the coming months, profiting from the spread. At Legacy West Partners, our acquisitions team is actively and aggressively pursuing deals in the 8.5% to 9.0% Cap Rate range, recognizing that this window of opportunity will soon diminish.