Post Financial Crisis, zero interest rates reshaped real estate pricing, cap rates, and investor expectations in ways we’re still unpacking. But that era is over. Zero interest rates weren’t just rare—they were historically abnormal. But in the aftermath of the Global Financial Crisis, central banks across the U.S., U.K., Germany, Japan, and beyond slashed rates to near-zero—and in some cases, below. What began as an emergency measure turned into a decade-long distortion, inflating asset prices, encouraging excess leverage, and masking risk across global markets.
As interest rates normalize, it’s important to revisit the basics: how rising rates reset cap rates, and what that means for core, core-plus, and value-add real estate strategies going forward. It’s a foundational shift, and understanding it is no longer optional.
An Introduction to Cap Rates and Their Relationship with Interest Rates
A property’s cap rate—calculated as the ratio of net operating income (NOI) to purchase price—is a key indicator of expected return and perceived risk. For stabilized assets, cap rates typically trade at a spread over the risk-free rate or prevailing interest rates, reflecting both the illiquidity and operational complexity of real estate. While higher interest rates usually exert upward pressure on cap rates due to increased borrowing costs, the relationship isn’t linear. Cap rates are also shaped by supply-demand dynamics, asset quality, location, and capital availability. In some periods, especially during monetary tightening, cap rate spreads can compress as risk appetite wanes, while in others they may widen as investors demand higher returns to justify equity risk.
CFA Institute Blog
Impact on Core, Core-Plus, and Value-Add Strategies
- Core Investments: These involve high-quality, low-risk properties with stable cash flows, often in prime locations. Investors in core assets typically expect annualized returns between 7% and 10%, with the majority generated through consistent cash flow rather than appreciation. As interest rates rise, the spread between cap rates and borrowing costs may narrow, potentially impacting the attractiveness of these investments.
YieldStreet
Origin Investments - Core-Plus Investments: These properties are similar to core assets but may require minor improvements or management efficiencies to enhance cash flows. They offer slightly higher returns due to the increased risk. In a rising interest rate environment, investors may need to carefully assess whether the potential for increased returns justifies the additional risk and higher borrowing costs.
- Value-Add Investments: These involve properties that require significant improvements or repositioning to increase NOI. While they offer higher potential returns, they also carry greater risk. Higher interest rates can impact the feasibility of these projects, as increased borrowing costs may affect overall profitability. However, successful value-add strategies can potentially offset these costs through substantial NOI growth.marejournal
Market Dynamics and Future Outlook
The normalization of interest rates is expected to influence cap rates across various property sectors. For instance, long-term projections suggest that industrial and multifamily cap rates may stabilize around 4.5%, office cap rates at 5%, and retail at 4.6%, all higher than their pre-COVID levels. Investors should monitor these trends and consider broader macroeconomic factors influencing Federal Reserve policies to understand cap rate movements better.
CBRE
As the real estate market adjusts to interest rate normalization, investors must recalibrate their strategies to navigate the evolving landscape. Understanding the nuanced relationship between interest rates and cap rates, and how it varies across different investment strategies, is essential for making informed decisions and achieving desired returns in this new environment.