Should Landowners Care About Cap Rates?

Over the past 12-18 months, we’ve seen the vacant look of boredom fall on the faces of some of our clients as we launch into the latest update on the 10-year treasury yield, its approximate effect on cap rates and what that means for property values. Some of these clients are undoubtedly wondering why we spend time talking about these things when all they want to do is sell their land for the best price to the most qualified buyer.

Roughly 50% of our business is selling land intended for the construction of multifamily units. The majority of these groups are merchant builders, meaning they build the units, lease them up and sell them. As cap rates fluctuate, so do the potential exit values of the projects they build, and therefore, the ultimate value they can pay for land. Things like rental rate growth, construction costs and interest rates all affect values, but the most powerful lever to be pulled is cap rate expansion and compression.

Check out the table below:

As the 10-year treasury yield moves and capital flows change, so do cap rates and necessary yields on construction cost (the return a developer needs to build to in order to hit their target profit). As we can see in the table above, when market cap rates move from 4.5% to 5.5%, a land value that was once attractive to the landowner at nearly $50k/unit, becomes a situation where the project is no longer viable.

What’s a Landowner to do?

In our experience, landowners are best served by making decisions based on their own situations and not by trying to catch the absolute top of the market. Multifamily land values peaked sometime in Q2 of 2022, but not many transactions closed at those peak valuations. Why? Most closings happening at that time had likely been in escrow for 12-18 months and were reflective of values from late 2020/early 2021.

Parcels put into escrow at those peak numbers were likely re-traded to lower prices or had their escrows canceled in the subsequent months as the Fed raised rates and the 10-year treasury yield climbed.

So, should landowners truly care about cap rates? The answer, unequivocally, is yes. For those involved in selling land earmarked for multifamily construction, understanding the intricate dance between cap rates, treasury yields, and property values is not merely an intellectual exercise, it is the key to understanding the market potential of their assets.

If you're interested in discussing factors that drive value on your property, please don't hesitate to reach out!

Thanks,

John and Ramey