For Two Days the 10-Year Treasury Broke 4%.

Article originally posted on Globe St. on March 3, 2023

Here’s What it Might Mean for Commercial Real Estate.

No, it doesn’t signal an end of the Treasury yield curve inversion, whether 10-year to 2-year, 10-year to 3-month, or any other variation you’d like to suggest. So, no, there isn’t a sudden end to that traditional sign of an upcoming recession.

However, yields on the 10-year have lifted above 4% for a couple of days now. And that has some implications, direct and indirect, for commercial real estate.

First, the 10-year’s yield has direct implications for borrowing costs.

“Materially higher interest rates can be expected to have an effect on commercial real estate, which is also being affected by changes of consumption patterns due to Covid,” Ian Toner, chief investment officer at investment consultancy Verus, tells GlobeSt.com.

The 10-year acts like a base starting point for various types of commercial lending, including CRE. Lenders add a spread on top of the 10-year interest to arrive at what a firm pays.

“It takes time for these effects to work through the market, but a significantly higher cost to finance projects and assets is likely to change investor perceptions around which assets are attractive, and at what price,” Toner adds.

And CRE isn’t disconnected from the rest of the economy. “Higher interest rates, all else being equal, are likely to slow the economy and put pressure on the pricing of assets that are generally bought with leverage,” says Toner.

But not all potential effects are necessarily bad. “A higher rate environment may create further downward pressure on inflation, which is already dropping,” Toner says, and lower inflation would definitely be good.. “Higher rates may also allow investors to meet their investment goals with simpler portfolios than before.”

There’s another aspect as well — the question of what a higher 10-year — if sustained (because this all could be a brief blip) — might do to other types of investments.

“The relative shine of equities is definitely dulled by rising yields across the Treasury curve. With short rates above 5% and 10-year yields on the verge of 4%, they represent credible alternatives to stocks where the S&P 500 is yielding approximately 1.8%,” Eric Leve, chief investment officer at wealth and investment management firm Bailard, told GlobeSt.com. “Equities have become much less attractive as yields have risen. At the same time, estimates for earnings growth in 2023 are coming down quickly, now implying essentially no earnings growth over 2022.”

If investors are put off from equities, real estate could be seen as a favorable alternative, especially given its traditional perception as a good hedge against inflation.