Jones Lang LaSalle


Torto Predicts End to Cap-Rate Compression Era
February 08, 2006
By Suzann D. Silverman, Editor-in-Chief

Ray Torto
Ray Torto expects capital to continue to flow into the real estate markets, but he also sees repricing and an end to the cap-rate compression era. Such were the predictions of the Torto Wheaton Research principal & chief strategist during the morning general session yesterday at the Mortgage Bankers Association's Commercial Real Estate Finance/Multifamily Housing Convention & Expo in Orlando.

While MBA chief economist & senior vice president of research and business development Douglas Duncan, who also offered predictions during the session, has forecast only a couple more interest-rate hikes this year, Torto quoted a Federal Reserve statement from the end of January that he believes suggests the Fed will raise both the federal funds rate and the 10-year Treasury rate still further. That, in turn, could cause cap rates to rise despite demand for real estate product (and the loss of some of the more risk-averse newer investors).

But that does not mean calamity for the industry. Noting that the 20-year interest rate average is 6.4 percent and the 30-year average is 7.8 percent, he estimated that a rise of, say, 6.16 percent would cause cap rates to rise only slowly, by 40 to 100 basis points over the next four years.

Thus, cap rates would still be relatively low, which given strengthening fundamentals would allow owners to continue to have cash flow growth--although not enough to avoid the current era of high single-digit returns. Such a level of returns will force more and more investors to move up the risk spectrum in search of more opportunistic, and therefore better-returning, purchases.