How low can they go? That’s the question many in the New York real estate world are asking right now about capitalization rates, or “cap rates.”
The rates, which measure an investor’s return on investment, or yield, are already at historic lows in Manhattan, and could continue to drop throughout 2014, sources say.
The lower the rate, the lower the return on investment. And as building prices climb due to sizzling demand, rates have been dipping ever lower in Manhattan. That’s because the hotter the real estate market, the more willing investors are to accept lower returns.
While changes to interest rates or the pace of rent increases could alter the trajectory, Manhattan’s investment sales market has been frenetic of late.
In the multi-family market, the cap rate for elevator apartment buildings was 3.4 percent in the first half of 2014, according to brokerage Massey Knakal Realty Services. That’s lower than the 4 percent seen at the end of 2013 — and the lowest since 2006.
For walkup buildings, the rate was 4.2 percent in the first half of 2014, the lowest since Massey Knakal began tracking it in 1984.
Similarly limp cap rates can be found in Manhattan’s office and retail sectors. For office buildings, cap rates were at 4.2 percent in the first half; for retail properties, 4 percent. Both figures represent drops from 4.5 and 4.8 percent, respectively, in 2013, as well as steep drops from 2009, when Massey Knakal began tracking those sectors.
Such low cap rates are not a surprise to brokers. That’s because, they say, real estate in the borough remains more lucrative than most other investment vehicles. “Every major investor across the world wants to be in New York,” said Jeffrey Oram, executive managing director at Colliers International.
In part that’s because cap rates are still higher than returns on Treasury notes, which have been flirting with zero percent. In other words, investing in Manhattan real estate remains more profitable than investing in the United States.
Nationally, yields have dropped too. In mid-August, the U.S. office and retail cap rates were both 6.9 percent, according to research firm Real Capital Analytics, and the apartment cap rate stood at 6.1 percent. All figures represent the lowest levels since RCA began tracking them in 2002.
Brokers say cap rates should continue to spiral down, because the Federal Reserve has long signaled that the interest rates that dictate borrowing costs will remain low into 2015. Brokers expect a gradual rise after that.
“As long as rates stay measured — they don’t sky-rocket overnight, they have a slow or orderly rise to them — real estate continues to do well,” said Doug Harmon, senior managing director at Eastdil Secured.
The X factor, then, is the pace of rents in multi-family buildings. “The anticipation is that rents will keep climbing up, [but] at a lower rate” said Shimon Shkury, managing member of Ariel Property Advisors. If rents keep rising, Manhattan cap rates should sink even lower, because building valuations will continue to rise with rent, overtaking any benefit from the increased income.
The median Manhattan apartment rent hit $3,300 in June, the highest in five years, according to appraisal firm Miller Samuel.
Commercial rents continue to rise, too. Average asking rent for Class A space in Manhattan reached $75.25 in July, from $69.26 last year, brokerage Cassidy Turley said.
Shkury noted that cap rates are still equal to, or higher than, borrowing costs. For instance, in mid-August, the floating rate on a 30-year commercial mortgage was, depending on variables like property size, between 3.35 and 4.5 percent — nearly identical to the cap rate for Manhattan elevator apartment buildings in the first half of the year.
And, while thousands of new apartments have come online in Manhattan in recent years and more will come in the next 12 months, they will not be enough to seriously dampen the hot market any time soon, brokers say. Tighter lending practices for condo buyers, too, are helping keep apartment demand steady, further bolstering the appeal of multi-family investment.
“You’ve got cap rate compression across the country,” Colliers’ Oram said. “And in the places where there’s the highest demand and the lowest perceived risk, the cap rates are going to go the lowest. New York is kind of the perfect storm … you’ve got incredible demand and amazing financing options.”