Most telling was a major San Francisco multi-family investor.
“If I purchase properties with low capitalization rates now, and interest rates and cap rates continue to rise, it would take several years of rent increases just to maintain the acquisition valuation.” And he noted that rents are in fact flattening or dropping for class B and C properties. So, he’s demanding cap rate valuation matching current mortgage rates. And he’s an investor who rarely sells.
Our developers are facing rising interest rates on construction financing, plus higher construction materials cost, and labor shortages.
While asking cap rates are generally unchanged, sellers have yet to appreciate buyers’ concerns.
One of San Francisco’s leading apartment broker said “most of the impact we have seen recently has to do with higher interest rates --4.5% versus 3.5%, a year ago. Although that is a concern, most owners don’t know the outcome yet, or how they should respond to it.”
Heidi Learner, chief economist at real estate services firm Savills Studley echoed the view.
“We have seen a bit of a slowdown in transaction volume, but we haven’t seen an upward move in cap rates over the last six to nine months as 10-year yields have essentially moved from 2 percent to 3 percent..I think a lot of investors are taking a wait and see view, not so much because of rates and what that implies for financing, but more because of the prospects for further rent growth,” she says.
For investors, the upward trend of cap rates will depend on the pace of rate increases.
That’s the view of Steve Kohn, president of Cushman & Wakefield equity, debt & structured finance. “If rates rise moderately over time, I think investors deal with that better than if there is a sudden major movement,” says Kohn.
But when investing in a hot market like the San Francisco Bay Area market, there's more at stake. With cap rates low, they don't want to be caught in even an ecosystem of gradual but steady rates hikes. A property acquired at a 3.5 cap rate will lose 30% value if cap rates jump to 5% no matter the pace of the increase. That's reason for caution.