Where are We?

We always find it useful to reorient ourselves with where things sit from a macro level and compare that to what would be considered a ‘normal’ environment (if there is such a thing). Right now, we’re seeing a Core PCE inflation reading of 2.8%, which sets the stage for how other financial benchmarks align.

As a reminder of something we’ve mentioned in a previous letter, the economist Peter Linneman sets the below expectations, which all key off of inflation (based on 2.8% Core PCE):

🔹 10-Year Treasury Expectation: 4.3% - 4.8% (1.50% - 2.00% above Core PCE)
🔹 "Quality" Apartment Cap Rate Expectation: 5.05% - 5.55% (0.75% above the 10-Year Yield)
🔹 New Construction Yield on Cost Expectation: 5.81% - 6.38% (estimated at a 15% premium over projected exit Cap Rate)

As of today, the 10-Year Treasury is hovering right around 4.5%, right in the middle of expectations, which puts the expected exit cap rate at 5.25% and the expected YOC at 6.04%. Again, this is for a “quality” apartment property, which leaves room for interpretation and markets don’t always adhere to expectation.

What Happens If Inflation Cools?

If Core PCE inflation falls to the Fed’s long-term goal of 2%, we could expect:
📉 10-Year Treasuries in the 3.5% - 4.0% range
📉 Cap Rates tightening to 4.25% - 4.75%
📉 New Construction Yield on Cost compressing to 4.9% - 5.5%

The Waiting Game

This suggests that simply holding assets until inflation and the yield on the 10-Year come down could create upside through cap rate compression. The catch? Timing is highly uncertain and the markets could actually move the other direction.

Nobody knows exactly when the Fed will reach its inflation target, and in the meantime, higher rates may keep valuations under pressure.

📢 What’s Your Take?
Are you making moves now, or are you waiting for the Fed to do its thing? Drop us a message—we’d love to hear your perspective.

Until next time,

John & Ramey