Commercial Real Estate Cap Rate Adjustment Speed Question
A few newby questions from a former Bulge Bracket abs/bond guy.  I sold a bunch of my parents CRE and am looking for replacement assets to 1031 into with reasonable leverage (i.e., 50%).   Based on how I view the world a few questions came up.  Here we go:

* How fast does the CRE market respond to interest rate changes?  I.e., how sticky are CRE prices?
* What is the appropriate maturity (e.g., the 10 or 20 year) to be pricing CRE cap rates off of given the lack of a duration measurement in CRE?  
* Is there a general rule on spreads based on risk profile?  
* Are CRE owner's generally sophisticated enough to listen to an argument of "hey you listed your property at X cap rate when the 10 year was trading at 1.5% and its now trading at \`\`\`\~3% and my financing has gone up by 150bps as well."

Also, given the recent inversion of the yield curve, I would really like to avoid putting this money to work now and park it in the equivalent of a shorter duration treasury (e.g. buy some 2 years) while we figure out what is going to happen with the economy.   Does anyone know of an equivalent CRE investment that is going to satisfy my 1031 requirements while focusing on reducing rate risk (or cap rate risk in this case) and capital preservation.

Thanks.
[{"id": "i67e2t4", "text": "A seller isn't going to care what your specific debt rate is.  The market price is the market price.  No one is adjusting pricing 150 bps because the 10 year has moved.", "replies": [{"id": "i67k897", "text": "So you are saying that the CRE market is insensitive to interest rates.  OK....", "replies": [{"id": "i67omzl", "text": "Nope, not saying that at all.  I'm saying that the market hasn't yet moved based on the 10 year, and that an individual or firm selling an asset doesn't care about your funding costs.  The price is the price.  While you're asking how sophisticated the CRE market as a whole is, consider that there's a time limit on 1031, and that sellers know that.  If you don't buy within the time frame, you lose what, 20% of your equity to taxes?  That's a bigger deal than the 150bps of extra yield on the debt.\n\nWithout knowing what price point you're looking at, I have no idea how sophisticated the buyers you are competing against or the sellers you are working with will be.  If you're trying to find someone who doesn't know what they're doing, hopefully you're under $1 million in a small market.  If you're over that, assume that people holding multi-million dollar assets in an asset class that's heavily reliant on debt financing are very sophisticated and very aware of what the interest rates are. Good luck.", "replies": [], "depth": 3}], "depth": 2}, {"id": "i68exee", "text": "That\u2019s not accurate. The cost of debt has certainly put a wet blanket on the market. I work for a PE shop that is simultaneously buying and selling about $1B of real estate this year and it has been brutal on both ends.", "replies": [{"id": "i696sti", "text": "We're still divesting at the prices we expected we'd be getting 3 months ago.  And we're not seeing price decreases on assets we're bidding on.  It's probably asset type specific, I could see the increase in debt costs hitting more speculative or value add assets harder than long lease institutional grade stuff.", "replies": [{"id": "i6afj25", "text": "I'm seeing the same.  Absolutely no movement in cap rates yet for quality assets.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "i67jav8", "text": "You already sold but attempting to 1031? Hope the proceeds are with a qualified intermediary.", "replies": [{"id": "i67jzx1", "text": "Under contract.  Not closed.  Contract assigned to a QI.", "replies": [], "depth": 2}], "depth": 1}, {"id": "i67lbz4", "text": "When interest rates changed in 2015-2018, CAP rates actually went down. I had clients looking at QSR properties in the 7% CAP range at the time. They thought as rates increased, they would be able to get a higher CAP on their purchases. Long story short....they didn't buy anything during that time period and now those properties are trading at 3.75 to 4.25% CAPS. Rates are up 150 bps and I have yet to see any repricing in the market...still seeing Auto Zones for 3.50% and Starbucks in the 3.75-4% range.", "replies": [{"id": "i67qnhs", "text": "This was helpful.  It sounds like CRE trades a lot less like the bond market and a lot more like the equity market, and to start picking up \"deals\" you really need to wait for the the rate tightening cycle to end (i.e., usually in a recession) and defaults to increase.  \n\nSo if I want to market time, my price of admission on that trade is an up front 20pts cap gain + 25pts on whatever depreciation I have to give back.  That's a tough ante to swallow....\n\nThanks for the insight.", "replies": [{"id": "i688et1", "text": "Yes. While real estate is tied to interest rates and debt definitely drives value, the correlation isn\u2019t as sticky as you\u2019d think. Debt costs have gone up 2x in multifamily in just a few weeks but prices are still within 5% of where they were. Recall that rent growth and value add programs are possible - therefore it isn\u2019t strictly driven off debt. \n\nYou are ultimately investing in an equity position, not a debt product.", "replies": [{"id": "i6a9z5p", "text": "Thanks.", "replies": [{"id": "i6bmgxy", "text": "Rate increases are driven by inflation which also includes rent growth so to some degree the effect on pricing is offset. Where I am seeing an effect is cash on cash being destroyed which ultimately makes fundraising harder which lowers what I can pay for deals. \n\nI also think some prices were agreed to weeks ago when deals launched and owners have not yet faced the music. Could also be that people just need to put capital somewhere so investors just suck up worse numbers.", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "i67tict", "text": "I recently read this summary from Colliers and found it a very interesting perspective and along the lines of your questions:\n\nhttps://knowledge-leader.colliers.com/aaron-jodka/colliers-quick-hits-cap-rate-spreads-are-narrowing/", "replies": [{"id": "i67wkw5", "text": "Super helpful.  Thanks.", "replies": [], "depth": 2}], "depth": 1}, {"id": "i67x7g5", "text": "You can 1031 into a DST.", "replies": [{"id": "i683sz9", "text": "Thanks.  I had thought of that and then the bond guy in me thought about the spreads on trades and I had a negative gastric reaction.  Having said that, it may be my best option and most liquid option here.\n\nCheers.", "replies": [{"id": "i68bem8", "text": "To better answer your question, you only have 4 options. \n\n1. Buy a replacement property. \n\n2. Invest in a property using a TIC (usually going to have limited options here). \n\n3. Invest in a DST. \n\n4. Invest in a Qualified Opportunity Zone Fund. This option has some materially different tax implications that you should research first. \n\nHow sticky are prices? IMO it will be year-end before we start to see any cap rate relief, if any at all. \n\nAppropriate maturity? 10T in most scenarios. \n\nRule on spreads? Not really. This is dependent on each individual\u2019s risk tolerance. The dark value, lease term remaining, property location, and some of the finer points of the lease all have an impact. Check out the website Net Lease Advisor to get an idea of where cap rates are. \n\nAre CRE owners sophisticated enough? Depends on the price point, but candidly, they don\u2019t care about your rising debt costs. It\u2019s still a seller\u2019s market.", "replies": [{"id": "i6aactb", "text": "Great answer thanks.", "replies": [{"id": "i8j8wvw", "text": "You can 1031 into my next deal \ud83d\ude09", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "i686ywi", "text": "If it meets the 1031 requirements, and if we're talking about enough money, you could buy high-end condos/townhouses in a mature market, I'm thinking Boston or New York. I'm pretty sure that asset class is good for capital preservation. Cash flow would suck even at 50% LTV, but that's why I think it's the best for capital preservation: cap rates don't apply here. And unlike SFR, which also isn't cap rate dependant but still sensitive to interest rates and negative effects of a recession, I feel like people who own luxury condos can weather recessions and wait out market adjustments, which props up market. Not saying it's 100% immune to effects of higher rates, but maybe worth looking into. And depending on your situation it could be a good write off.", "replies": [{"id": "i6aaid5", "text": "Thanks.  I was generally looking at NNN investments, but this is worth putting on the list.", "replies": [], "depth": 2}], "depth": 1}, {"id": "i68ek6m", "text": "There\u2019s a lag but yes deals are starting to fall out in the sophisticated end of the market - mainly due to higher cost of capital which causes negative leverage. The indexes are up, but so are spreads so all in rates have expanded by at least 100 bps (floating rate) and 200 bps (fixed rate). 3 months ago, a 2.5% cap worked, now it doesn\u2019t so deals are falling out and sellers are getting retraded. It takes a while for this to happen enough in multiple markets to then be reported as \u201ccap rates higher!\u201d\n\nGenerally, investors use the 10 year and generally the spread to cap rate is anywhere from 100 bps to 300 with a lot of variability on geography, property type and deal size. A large stabilized crossed pool of industrial warehouses with credit and WALT will trade very tight compared to a 75% leased cbd office building. But generally that range is where cap rates fall historically. \n\nGeneral rule on spreads based on risk - apts, industrial, medical office/life science will trade tighter. Retail, office and hotel wider. The exception is grocery anchored retail which has crushed it and will continue to trade tight.\n\nYou can make whatever \u201csophisticated\u201d claim to the seller, but end of the day someone else may be willing to pay more / take a lower yield / not need leverage and the seller\u2019s broker\u2019s job is find that buyer. But yes, generally buyers are asking for haircuts due to lending environment. \n\nYour last question - I don\u2019t think that exists. 1031 rules are very narrow, so you\u2019d want to talk to a tax attorney to make sure you don\u2019t fuck it up. Also, transaction costs will eat you alive compared to clicking a button and buying a bond. You may look into investing into a high yield credit fund, but again I don\u2019t think that will qualify for the down leg.", "replies": [{"id": "i6ab5ih", "text": "Many thanks.  This is exactly the sort of email I would have expected from an MD-ish RE guy in my former shop.", "replies": [{"id": "i6d2gry", "text": "Happy to help. Another strategy for 1031 is to bank covered land plays in generational locations and then figure out what to do while you have cash flow covering the carry costs. I don\u2019t know how much money you\u2019re dealing with, but larger HNW guys do this a lot. Good luck!", "replies": [{"id": "i6rc9xr", "text": "Could you please elaborate on what a covered land play is? I'm in the same situation as op.", "replies": [{"id": "i6sdt2u", "text": "Property with tenant in place to bring income, but not currently 'best use' of land. Keep income while working on redevelopment opportunities", "replies": [{"id": "i6u3bec", "text": "This ^", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "i68jwkb", "text": "Depends what price point you are talking about as far as making your argument to a seller but generally a Seller's mindset doesn't adjust to fluctuations in interest rates very quickly which will make your exchange a bit challenging.", "replies": [], "depth": 1}, {"id": "i68z7kv", "text": "CRE Values are generally calculated before debt servicing. NOI/ CAP = Value. So investors end up just contributing more equity to get deals done. Rates are temporary, price is forever. Also, valuations require trades for appraisers to revalue the market. You will see some people in trouble on renewals over the next 12 months and decide to sell and that should have an impact but it's really anyone's guess. I'm seeing lots of new development projects wait on the sidelines because the equity requirements are so much bigger.", "replies": [{"id": "i7f14sl", "text": "buyers are seeking yield. if the debt component of their deal becomes more expensive, they will either accept lower return or attempt to negotiate a lower price.  If other parties in the market are willing to accept the lower return, then prices won't move.   I believe cap rates are already starting to shift for certain NNN asset classes.", "replies": [], "depth": 2}], "depth": 1}]