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Triple-net leased properties are closely hewing to 10-year Treasury note rise and fall. Will this trend continue?

For the last five years, cap rates have been compressing from an average of 7.19 percent in 2010 to a low of 6.35 percent shortly before the 2016 U.S. presidential election. This has been due primarily to falling interest rates, which reflects the historically low rates on the 10-year Treasury note. In the financial realm, the 10-year Treasury is the benchmark rate on which many assets either directly or indirectly derive their value.

Since triple-net leased properties with investment-grade, credit-rated tenants are much closer to financial transactions than many real estate investments, it makes sense to expect these properties will react more to swings in interest rates.

However, research shows triple-net transactions have traded in a fairly tight range of 350 to 540 basis points above the 10-year Treasury during the last several years. This compares to investment-rated corporate bonds, which are priced based on the 10-year Treasury with spreads closer to 100 to 150 basis points due to less risk and greater liquidity.

The spread above the 10-year Treasury bill is just a premium attached on the required rate of return of commercial real estate buyers to properties. It is largely a function of real estate’s relative illiquidity as compared to bonds.

This compensates buyers because they cannot turn the property into cash as quickly as they can sell the bond, resulting in more market risk.

Read more at ccim.com

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