**The Relationship Between Cap Rates and Interest Rates**
The Federal Open Market Committee is scheduled to meet on September 16–17, and most economists anticipate that the Federal Reserve will move to cut interest rates. But by how much? That remains uncertain, especially following the latest Consumer Price Index report showing an annual inflation uptick of 2.9%.
In the real estate world, the prevailing belief is that a Fed-initiated interest rate cut will lead to a contraction in capitalization (cap) rates, which could subsequently boost property valuations. However, recent insights suggest the relationship between interest rates and cap rates is more complex.
**New Insights: Cap Rates and Interest Rate Movements**
According to Marcus & Millichap’s report, “If Interest Rates Ease, Will Cap Rates Follow? Analysis Reveals More Relevant Indicator,” data indicates only a limited correlation between interest rates and cap rates. While both the 10-year Treasury yield and average cap rates have generally declined over the past 30 years, they often trend independently of one another.
Examples from historical data include:
– From October 2001 through June 2025, the 10-year Treasury yield had only a 40% correlation with average apartment cap rates.
– In both 1994 and 1996, Treasury yields spiked, yet cap rates moved lower.
– Between 2002 and 2006, the 10-year yield rose gradually while cap rates steadily declined.
– From 2006 to 2008, cap rates increased even as Treasury yields fell sharply.
**So, What Actually Drives Cap Rates?**
Two words—transaction velocity. Marcus & Millichap’s research found a strong 78% correlation between market activity (transaction volume) and cap rate movements since 2001.
Additional data points include:
– From 2002–2006, as transaction volume rose, cap rates declined.
– From 2007–2010, transaction activity decreased while cap rates increased.
– The transaction flurry seen in 2021 and 2023 aligned with falling cap rates. Conversely, when volume dropped starting in late 2023, cap rates rose again.
**A More Nuanced Landscape**
Interestingly, the correlation between interest rates and transaction volume has, until recently, been relatively weak—only about 30%. However, as higher interest rates in 2023 and 2024 dampened transaction activity, analysts suggest a decrease in rates could spur a rebound in deal flow.
This potential uptick may also be driven by other factors, such as available dry powder on the sidelines, looming debt maturities, and recent tax reforms. Even if Treasury yields remain stable, these influences could still spark increased sales activity—and, with it, the potential softening of cap rates.
Still, the market shouldn’t expect immediate changes. This is a gradual shift, but one that could present opportunities for attentive investors.
