What Does the Cap Rate vs. Interest Rate Spread in CRE Property Investments Tell Us?

This topic is liable to be of keen interest in many quarters.  Using a very recent transaction as an example, we found a commercial real estate private placement offering of securities for a Delaware Statutory Trust (DST) had a an effective long-term debt interest rate of 4.4011% and a going-in cap rate of 4.79%.  That’s a spread of less than 38 basis points!  The transaction was not huge – a total offering of approximately $82 million for three (3) properties, but still a bit of shock and points to a variety of larger issues. Equity was approximately 58% of the capital sources in the transaction and the beneficiaries are projected to receive an IRR on their investment of around 9%, but that 9% IRR is greatly dependent upon no change in conditions in the capital markets or the local property trade area for the 10-year mandatory holding period.

The issue that stands out to me the most is the reliance of the investing-public on the notion the markets won’t change and the belief that cap rates and interest rates will remain where they are, even though we all know the rates are at historical lows that can only go up from here.  All of this speaks to a growing belief in a booming CRE economy, robust capital market reflex to said boom and a lack of any materially-significant asset obsolescence risk that would otherwise be a factor.  I don’t think any of these propositions are sustainable over 10 years, so there has to be something else.

What do you think?

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