Cap rate expansion has been an issue for much of 2023. These expansions were anticipated to peak by Q4 2023 and decrease throughout 2024 as the Federal Reserve possibly ended its rate-hike cycle.
But Matthews Real Estate Investment Services said this might not be the case. Its article “Deep Dive into Cap Rates: Will Cap Rate Expansion Continue in 2024?” indicated that decreasing cap rates is not necessarily a sure thing.
The Cap Rate Expansion
The article explained that cap rate expansion can mean higher profits. But higher cap rates can also signal more risk. “Buyers expect lower property pricing to offset this risk to improve their odds and ensure higher yields,” the article explained. Real Capital Analytics said the all-property year-over-year price change fell by 9.9%.
The article also explained the factors behind higher cap rates, including the ongoing increase in the Effective Federal Fund Rate. The Federal Reserve’s rate hikes have helped decrease inflation. But “as the cost of borrowing increases, investors require a higher return, and cap rates increase,” the Matthews article pointed out.
Market dynamics have also led to increases. Dwindling demand means sellers need to lower the pricing of their properties. Finally, macro issues like the COVID-19 pandemic can also impact cap rates. The article explained that increased e-commerce led to exploding demand for warehouse and logistic centers during the pandemic.
Additionally, more people fled to the suburbs, leading to a multifamily “supply and demand imbalance throughout several secondary markets in the U.S.,” the article explained.
The article noted that the industrial, multifamily and retail sectors have experienced cap rate expansion to varying degrees throughout 2023. In addition, “the rapid increase in interest rates means lower pricing on acquisitions is necessary to achieve healthy returns,” the article said.
However, the challenge is that the pricing gap hasn’t yet been realized.
This means that cap rates should peak in Q4 2023 “but expand at a slower rate until interest rates fall and stabilize in 2024,” the Matthews article said. The article anticipates that a price discovery phase should occur from Q4 2023 through the first half of 2024, meaning an increase in transaction volume. If the Federal Reserve lowers interest rates this should also help “cap rates decrease and investors to secure debt at a more affordable price,” the article explained.