Treasury yields near 5.3% leave private real estate appraisals below the risk-free rate

Pierzak's own figures locate the appraisals. The 10-year is about 5.3% ^[3] and has risen close to 90 basis points since the end of the second quarter ^[10]. He said appraised cap rates and the Treasury "were almost at parity" at that quarter-end ^[12], so both sat near 4.4% ^[13].

A cap rate turns income into a price, so the repricing is easy to size. Hold net operating income flat and lift a 4.4% cap rate to 5.3%, merely level with Treasuries, and the property is worth about 17% less ^[14]. Appraisals are the low side of the gap with REITs, because appraisers have held their rates steady ^[2]. Closing the 127 basis points Nareit measured ^[6] means a cap rate near 5.7% and a value cut of about 22% ^[15].

Pierzak expects some of that to show up. Of the relationship with Treasuries, he said "the appraisal rate is hugging the 10-year rate. That is untenable." ^[7] On the coming quarterly readings, he said: "I don't see how you can't. But the question is whether it will be a modest, measured increase or something more sizable." ^[11]

The readings can go three ways. Appraisers can lift cap rates by close to the 90 basis points the Treasury has added, put private yields back above the risk-free rate and book the 17% in one quarter. They can make the measured increase and leave appraisals yielding less than the 10-year. Or they can move and still lose ground. The selloff since July will raise the next implied REIT cap rate ^[5], and a measured private increase could leave the gap as wide as the 127 basis points of the second quarter ^[6].

I'd expect the measured version, and the fund Pierzak described is the reason. Its tender at around 95% of NAV is a 5% haircut ^[8]. On an unlevered building at a 4.4% cap rate, a 5% cut in value is the same as a cap rate rise of about 23 basis points ^[16]. The fund did not say how much it would buy, and senior management said it would put more money in ^[8]. So the manager is spending fee income, its executives' own money and its departing investors' 5% to avoid selling buildings at prices that would set a mark. "These are all pushes for alignment, but they are expensive in and of themselves," Pierzak said. "Yet it appears more palatable to management teams to take these measures than to mark to market and sell assets." ^[9]

The counter-case is the Treasury move itself. A negative risk premium of roughly 90 basis points ^[17] is hard for an appraiser to defend, and Pierzak expects an upward adjustment ^[11]. The view is wrong if third-quarter appraised cap rates rise by something close to that 90 basis points. A rise near the 23 basis points the tender implies would still leave appraisals about 67 basis points under a 5.3% Treasury ^[18].