With interest rates rising and expected to keep rising for the near future, expect commercial real estate capitalization rates to rise as well.  

According to a recent report from a National Association of Realtors (NAR) research economist, however, the rise will be modest. Capitalization rates and prices work inversely — commercial property prices generally go up when cap rates come down, while prices generally fall when cap rates go up.

Here are some excerpts from the report.  

“Though interest rates have been rising amid mounting inflation and the Fed’s efforts to control inflation by raising the federal funds rate (with anticipated rate increases), investors are factoring in the strong demand for commercial assets and local economic conditions.  While cap rates are positively associated with the 10-year yield, cap rates don’t move in lockstep with it.
For example, during the height of the pandemic in the third quarter of 2020, the risk spread for office and retail, which were the hardest hit assets after the economy went into a lockdown and many businesses remained closed, rose to as high as
6 percent. With an improving economy and the reopening of businesses, the risk premium for office and retail assets has compressed to around 4 percent.” Risk premium is calculated as the nominal cap rate less the 10-year Treasury note yield.

The report continued: “As of the first quarter of 2022, the apartment market had the lowest risk premium at  2.5 percent (3.5 percent one year ago). With strong apartment demand, cap rates are likely to hover at 4.5 percent.  Industrial cap rates have also trended downwards to 3.5 percent (4.3 percent one year ago). Rising inflation will hit the retail sector the most, as consumers cut back on non-essential spending. With slower consumer spending, cap rates are expected to rise to 6.3 percent from the current level of 6.1 percent  At the height of the pandemic in the second quarter of 2020, cap rates were at 6.6 percent.  Office cap rates are likely to hover at 6.3 percent from the current level of 6.1 percent.  

Keep in mind the above numbers are national averages derived from multiple sources and don’t necessarily reflect the commercial real estate cap rates in Grand Junction and Mesa County. Remember: All real estate markets are local.