Higher Yield Spread and the Economy

[Russell Gronsky]

I was just reading a commercial RE blog and I don't understand the following phrase:

"...with the widening of the higher yield spread, we will see higher cap rates."

The article in full is here:

https://www.globest.com/2018/12/21/are-investors-p...

What is "higher yield"? Is that related to bonds? Treasury notes? Interest rates?

[Joel Owens]

Commercial real estate if not paying cash you look at spread between debt and cap rate. That can be a spread yield. Example a 5% interest rate and a 7% cap rate is a 200 basis point spread.

The article mentions general office which I do not like as an investment class anyways. Regular office when economy is good they branch out into their own locations and sign leases. When economy goes down the tenants tend to move to cheaper warehouse space at less rent per sq ft or back into their home office to try and save costs. 80% of small business especially office work on small profit margins so any major shift they feel it more.

Apartments in certain classes people think they are darlings and can't do any wrong. The renters incomes to rent ratio is very high meaning they are (tapping out) from being able to pay much more rent. So investors squeezing yields to try to increase NOI might can expect a downturn if the economy goes back down. Last downturn 2007-2009 I saw infighting between multifamily landlords to maintain market share as rent increases flatlined and vacancy increased.

Retail I specialize in and not seeing much movement up on cap rates. Maybe 25 to 50 basis points or so on medium size properties in the 3 to 5 million range. Lower price 2 million and below high quality assets many are purchased all cash so they do not care about debt versus cap rate spreads and interest rates rising etc. When you get into larger properties I have seen maybe 75 to 100 basis point spreads movement over the last 12 months.

The article you posted is more general in nature. Information can be split tons of different ways. Trumps tax policy did likely extend another 2 to 3 years past the normal full cycle an uptrend. The investors I have are millions into tens of millions or higher of capital to invest so they are not affected as much by a recession as your average worker making 50,000 a year income.  The investor who has one or two small residential properties and dependent on that rental cash flow to paydown those mortgages can get into trouble in a downturn when their tenants can no longer pay the rent or only partial.