If you’ve been wondering what’s a good cap rate, check out this chart. Historically, the average spread between the cap rate and the 10 Year Treasury Long-Term Average has been 440 basis points. In simple terms, if I can invest money in a 10 year treasury bond, I expect a lower return on my money. It’s a safer investment. But, if I invest in commercial real estate, then I expect a higher return, which means that I should see a risk premium or mark up above the 10 year treasury rate.
In this case, a good cap rate is 440 basis points higher than the 10 Year Treasury. That’s good news if you’re concerned about historical performance. However, keep in mind that treasury rates are very low today and they may be artificially low due to foreign capital demand for U.S. debt, QE programs being run by our Federal Reserve Bank, and stock investors seeking “safer” returns in a volatile equities environment.
To me, commercial real estate investments still look like a winner with good cap rates providing a healthy spread between 10 Year Treasuries and real estate values. Once you see, however, the spread shrink to less than 300 basis points, beware.
Check out the spread from 2005-2008. Remember those days?