SFR Cap Rates Hold Steady as Benchmark Interest Rates Fall

Cap Rates Remain Stable in 2019

Throughout this cycle, cap rates — the relationship between net operating income (NOI) and property values — have consistently fallen. The steady drop has come as the SFR sector has formalized, liquidity has improved and benchmark yields have similarly found new depths.

Dating back to 2012, SFR cap rates reached a high of 11.0%. In the years since, they have dropped by more than 470 basis points (bps) to 6.3%.

The decline represents a 43% reduction in yield as property prices have accelerated more quickly than property-level incomes.

SFR cap rates hit their lowest levels on record in third-quarter 2018, reaching 6.2%. Over the past year, cap rates have bounced around in a tight 20-bps range between 6.2% and 6.4%.

SFR Cap Rate Spreads Widen

Analyzing cap rates across a broad spectrum of other market yields provides valuable context as to how investors and lenders view the SFR sector. The risk-free interest rate, best captured by the 10-year U.S. Treasury, is built into the yield structure of all other market securities and investments.

The difference in yield on top of the 10-year Treasury is referred to as the “risk premium.” Put another way, it is the amount of additional compensation an investor requires based on a perceived level of risk.

In the early days of the housing recovery, the spread between SFR cap rates and the 10-year Treasury hit a high of 9.1%.

As the sector achieved a positive reputation and operational efficiency, the spread dramatically fell, touching down to a low of 3.2% in fourth-quarter 2018.

Treasury yields are continuing along their unpredictable ride. From peak to trough, Treasury rates have fallen by more than 170 bps in less than a year. SFR cap rate stability measured against Treasury volatility has led to a widening of the spread, currently sitting at 450 bps.

A growing spread between SFR cap rates and Treasuries raises the question, have SFRs become riskier compared to other investments? The answer, when compared to other forms of real estate, appears to be “no.” The average cap rate difference on SFR and multifamily investments has settled just above 1% and has barely budged for more than a year.

For a more in-depth analysis of SFR performance metrics and market developments, read our Q3 2019 Single-Family Rental Investment Trends Report, available on the Chatter Blog.

Note: All data are based on Chandan Economics’ model estimates, unless otherwise stated.