Treasury Yields, Yield Curve and Why Commercial Real Estate Investors Need To Watch These Carefully (2024)

If you have watched any recent news related to Commercial Real Estate (CRE) investing then you've heard terms like Treasury yields and Yield curves. Today I'll try to demystify these terms and what they mean for CRE investors.

Treasury yield refers to the interest rate or yield on government-issued debt securities known as Treasury securities or Treasury bonds. These securities are issued by the United States Department of the Treasury to finance government operations and manage the national debt. Treasury yields play a crucial role in the financial markets and serve as benchmarks for various interest rates across the economy. The treasuries have different maturity dates varying from short (3 months) to long term (30 years)

SHORT AND LONG TERM YIELDS

Both short-term and long-term Treasury yields play important roles in shaping borrowing costs, investor sentiment, and market dynamics in the commercial real estate sector. Investors and stakeholders closely monitor changes in Treasury yields as part of their risk assessment and decision-making process when evaluating commercial real estate investments. Understanding the implications of short-term and long-term yield movements can help investors navigate market conditions and capitalize on opportunities in the CRE market.

Now let's look at the 2-year and 10-year Treasury yields a little closely as they are important indicators for commercial real estate investments, although in slightly different ways.

2-Year Treasury Yield:

• The 2-year Treasury yield reflects shorter-term interest rate expectations and is influenced by factors such as monetary policy decisions by the Federal Reserve, economic data releases, and market sentiment regarding near-term economic conditions. The 2-year Treasury yield can influence short-term financing costs for commercial real estate acquisitions, refinancing, and development projects. Changes in the 2-year yield may impact the interest rates on floating-rate commercial mortgages and short-term financing options.Investors and developers may monitor the 2-year yield to gauge near-term interest rate trends and adjust financing strategies accordingly. Lower 2-year yields may present opportunities for borrowers to secure favorable short-term financing terms.

10-Year Treasury Yield:

• The 10-year Treasury yield represents longer-term interest rate expectations and is influenced by factors such as inflation expectations, economic growth prospects, and global market conditions. It serves as a key benchmark for long-term borrowing costs in the financial markets. The 10-year Treasury yield has a more significant impact on long-term financing costs for commercial real estate investments, including permanent financing for acquisitions, refinancing, and development projects. Changes in the 10-year yield can affect the rates on fixed-rate commercial mortgages and long-term loans.Investors and lenders closely monitor the 10-year yield as an indicator of future borrowing costs and overall market sentiment. Rising 10-year yields may lead to higher borrowing costs for long-term financing, potentially affecting property valuations and investment returns.

Both the 2-year and 10-year Treasury yields play important roles in shaping financing costs, investor sentiment, and investment decisions in the commercial real estate market. While the 2-year yield reflects short-term interest rate expectations and impacts short-term financing options, the 10-year yield influences long-term borrowing costs and has broader implications for property valuations and investment returns over extended periods. Investors and stakeholders in the CRE market monitor both Treasury yields as part of their risk assessment and decision-making process.

YIELD CURVE

A yield curve is a graphical representation of the relationship between interest rates (yields) and the maturity dates of debt securities, typically government bonds, plotted on a graph. The yield curve shows the yields of bonds with different maturities, ranging from short-term to long-term. It is an essential indicator of the bond market's expectations for future interest rates and economic conditions.

Shape of the Yield Curve:

• Normal Yield Curve:In a normal yield curve, longer-term bonds have higher yields than shorter-term bonds. This reflects the expectation of higher future interest rates due to factors such as economic growth and inflation expectations.
• Inverted Yield Curve:An inverted yield curve occurs when short-term bond yields are higher than long-term bond yields. This unusual shape of the yield curve is often interpreted as a signal of impending economic downturn or recession.
• Flat Yield Curve:A flat yield curve occurs when there is little difference between short-term and long-term bond yields. This shape of the yield curve may indicate uncertainty or mixed expectations about future interest rates and economic conditions.

Impact on CRE:

• Borrowing Costs:The shape of the yield curve can influence borrowing costs for CRE investors. Changes in the yield curve, particularly in long-term interest rates, affect the pricing of commercial mortgages and other financing options. A steepening yield curve, where long-term rates rise relative to short-term rates, may lead to higher borrowing costs for long-term financing, potentially impacting property acquisition and development.
• Capitalization Rates (Cap Rates):Changes in the yield curve can impact capitalization rates (cap rates), which are a key metric used in commercial real estate valuation. Cap rates reflect the relationship between property income and value and are influenced by prevailing interest rates and investor expectations. A steepening yield curve may lead to higher cap rates if investors demand higher yields to compensate for rising interest rates and perceived risks.
• Property Valuations:Changes in interest rates driven by the yield curve can affect property valuations in the commercial real estate market. Rising interest rates may reduce property values if higher borrowing costs result in lower cash flows or higher discount rates applied to future income streams.

In summary, the yield curve serves as an important indicator of bond market expectations for future interest rates and economic conditions. Changes in the yield curve can impact borrowing costs, capitalization rates, and property valuations in the commercial real estate market, influencing investment decisions and market dynamics. Investors and stakeholders in CRE closely monitor the yield curve as part of their risk assessment and decision-making process.

Stay tuned for more on this series of educational articles - a mix of market and economic insights for smarter CRE investing.