CRE Investors Should Watch the Bond Market—Not Just the Fed

07/27/2025

Industry Insights Deal Book

Cap Rates and Treasury Yields: Understanding the Core Relationship

Commercial real estate investors have long benchmarked property values against the bond market. A property’s capitalization rate (cap rate) – essentially the annual net operating income divided by the purchase price – is often compared to the 10-year U.S. Treasury yield, the quintessential “risk-free” rate for long-term capital. The logic is straightforward: investors demand a premium yield over safe Treasuries to compensate for the risks and illiquidity of real estate. Historically, U.S. CRE cap rates have indeed offered a spread of a few hundred basis points above the 10-year Treasury. Since the early 1990s, average cap rates have hovered around 3% to 4% higher than the 10-year Treasury yield (Northmarq – The Main Ingredient: Interest Rates and Commercial Real Estate). This risk premium isn’t fixed – it narrows and widens with market cycles. In frothy periods, the spread can shrink dramatically (at the 2007 market peak, cap rates for top properties were barely 0.5% above Treasuries), whereas in downturns it can spike (during the 2009 crisis, cap rates soared to nearly 5% above Treasuries).

Different property types also carry different typical spreads. For example, multifamily apartment investments have tended to trade at lower cap rates (only about 2.3 percentage points above the 10-year Treasury on average in the 2010s) given their stability, whereas riskier or less liquid sectors like retail and industrial often saw spreads in the 3.0%–3.5% range (CBRE Econometric Advisors – A Multi-Perspective View on Cap Rates). These variations reflect the market’s assessment of each sector’s risk and growth prospects. The key point is that the 10-year Treasury yield acts as the baseline yardstick for value: when Treasuries rise or fall, they pull cap rates (and thus property values) in the same direction over time. But the relationship is not one-to-one or instantaneous – it’s nuanced, as we’ll explore.

How Bond Yields Drive CRE Financing and Values

Borrowing Costs: The most direct transmission from the bond market to commercial real estate is through debt financing. Most fixed-rate CRE loans (whether portfolio loans, conduit CMBS, or agency multifamily loans) are tied to long-term benchmarks like the 10-year Treasury or interest rate swaps. Lenders quote spreads above these benchmarks. As a result, when Treasury yields rise, the interest rates on new commercial mortgages climb in tandem. Higher borrowing costs mean higher debt service payments, which in turn squeeze project cash flows and debt coverage ratios. In practical terms, when the cost of capital increases, buyers cannot afford to pay as high a price for the same net income – either leverage levels drop or prices must adjust downward. Conversely, when bond yields fall to historic lows, borrowers can lock in cheaper debt that supports higher property valuations. This is why a savvy investor watches the 10-year yield as closely as their lender’s term sheet – one informs the other.

Valuation and Cap Rates: Bond yields also influence the return expectations of equity investors in CRE. If the 10-year Treasury is at 5%, an investor will demand a higher cap rate (say 8%+) on a speculative office building to justify the risk, whereas if the 10-year is at 1%, that same investor might accept a 5% cap rate for the asset. In general, rising Treasury yields put upward pressure on cap rates, which means property values decline (since cap rate is effectively the inverse of a price/earnings multiple for real estate). Falling yields have the opposite effect – they often help compress cap rates and inflate asset values, as investors are willing to pay more for income-producing properties when safer alternatives yield little. However, this mechanism is tempered by other factors: the availability of credit, investor sentiment, and rent growth expectations. For instance, during periods of robust economic growth or abundant liquidity, cap rates may hold low (prices high) even if bond yields are creeping up. In contrast, if lenders pull back or market sentiment sours, cap rates can jump abruptly regardless of what the Fed is doing. In short, bond yields set the underlying climate for CRE valuations, but local weather can still shift day to day.

Strategic Implications for Different Stakeholders

Brokers and Developers

For brokers, understanding the bond market’s influence is crucial in guiding clients. When marketing a property, a broker might frame the cap rate relative to the current 10-year Treasury yield (“This multifamily asset offers a 400 basis point spread over Treasuries”), positioning it as an attractive risk-adjusted return. Brokers and developers also time the market: if long-term rates are on the rise, there may be urgency to close deals or refinance projects before financing costs climb further. Conversely, in a declining rate environment, developers might push to lock in construction loans and permanent financing at lower rates, improving project feasibility. The takeaway is that brokers and developers who track bond yield trends can better advise on pricing, deal timing, and when to refinance or sell assets.

Institutional & High-Net-Worth Investors

Long-term investors like pension funds, REITs, private equity funds, and family offices carefully watch the 10-year yield as a barometer for portfolio strategy. These investors often set target acquisition cap rates or hurdle rates based on the risk-free rate plus a spread. A widening gap between cap rates and Treasuries might signal a buying opportunity (assets potentially undervalued relative to bonds), whereas a narrow spread could signal caution or a time to sell and take profits. For instance, if benchmark yields plunge and cap rates don’t immediately follow, the spread balloons – an investor might see that as an opportune moment to lock in a high spread by acquiring property before cap rates inevitably compress. Allocation decisions between core stable assets and more opportunistic deals also shift with the yield curve. In a low-rate, flat yield curve scenario, investors may move up the risk spectrum (since even safe assets offer thinner premiums), while a high-rate environment with a steep yield curve might encourage a flight to quality. The sophisticated CRE investor effectively uses the bond market as an early warning system and a guide for entry and exit timing.

CRE Technology and Data Professionals

The rise of data analytics in real estate means even tech-oriented professionals need to keep bond market data in their toolkits. Software platforms and investment dashboards are now integrating live Treasury yield feeds, allowing users to model how an interest rate change might impact valuations and cap rates in various markets. For example, underwriting software can automatically stress-test a property’s cash flow against a scenario where the 10-year Treasury jumps 100 basis points – revealing whether the deal would still meet the lender’s debt service coverage requirements. PropTech firms that serve brokers and investors are also building tools to visualize cap rate trends versus Treasury yields over time, helping users spot when spreads are abnormally tight or wide. In short, tech professionals in CRE add value by marrying traditional real estate metrics with bond market intelligence, giving clients a forward-looking edge.

Global and Macro Strategists

At the macro level, commercial real estate does not exist in a vacuum – it competes for capital on the world stage. Global investors routinely compare U.S. cap rates to bond yields both domestically and abroad. If U.S. Treasuries are yielding more than some foreign government bonds, U.S. real estate may actually look more attractive to overseas buyers (who see a healthy spread and perhaps currency upside). On the other hand, if U.S. bond yields spike sharply, some international investors may retrench, finding U.S. assets less appealing or facing higher hedging costs. We also have to consider the impact of major bond market moves driven by central banks. For example, when large holders of U.S. Treasuries (like foreign central banks or the Federal Reserve itself) buy or sell in volume, it moves yields. A surge in Treasury selling can send yields upward, filtering through to higher mortgage rates and cap rates that slow down CRE investment. Thus, CRE strategists monitor not just the Fed’s pronouncements but also bond market signals like yield curve inversions (often a recession indicator) or changes in the term premium. These give clues about where property markets might be headed. In essence, keeping an eye on the bond market – globally and nationally – helps CRE professionals anticipate capital flows into real estate and adjust strategies accordingly.

Beyond the Basics: Nuances and Emerging Risks

Cap Rates Don’t Move in Lockstep with the Fed

It’s a common misconception that if the Federal Reserve raises interest rates, cap rates will automatically jump in parallel (and vice versa). In reality, the connection is more complex. Cap rates are influenced by the entire yield curve, not just the overnight Fed funds rate, and even more so by investor sentiment and growth expectations. There have been periods when cap rates actually fell despite rising Treasury yields. A classic example is the mid-2000s: from 2003 to 2006, the Fed was hiking and the 10-year Treasury yield rose substantially, yet cap rates for many property types compressed during that time because abundant capital and bullish rent projections drove fierce competition for assets. More recently, industry analyses have found only a very low long-term correlation between cap rates and the 10-year yield. In fact, one study noted a near-zero statistical correlation over several decades, with multiple instances (such as 2001–2004 and 2020–2022) where real estate yields moved in the opposite direction of bond yields (Ares Wealth Management – Historical Cap Rates vs. Treasury Yields). The takeaway: rising interest rates do create pressure for higher cap rates, but the adjustment can be muted or delayed if other forces – like strong income growth, high liquidity, or simply investor optimism – are at play. Likewise, when the Fed slashes rates, don’t expect property cap rates to immediately plunge without considering credit conditions and investor demand.

Spread Cycles and Market Sentiment

The risk premium (spread) between cap rates and Treasuries tends to ebb and flow with the market cycle. In good times when capital is abundant and confidence is high, investors accept smaller spreads – they’ll pay more for property relative to the safe yield. This “spread compression” was evident in the late 2010s and again in 2021 when massive liquidity and low rates saw cap rate spreads tighten considerably below historical norms. On the flip side, during periods of uncertainty or credit tightness, spreads usually widen out. For example, early in the pandemic in 2020, Treasury yields collapsed to record lows as investors flocked to safety, but very few property sales occurred at commensurately low cap rates; buyers and lenders pulled back, effectively increasing the spread. Similarly, in 2022–2023, as interest rates surged, transaction volumes plummeted and many sellers refused to budge on pricing immediately – this created an unusually thin spread (in some cases near zero) between average cap rates and the now-higher Treasury yields. Over time, either cap rates had to rise or bond yields had to fall to re-establish a normal gap. Observing these cycles, seasoned investors know that today’s unusually tight or wide spreads won’t last forever. They plan accordingly: anticipating, for instance, that if and when the Federal Reserve signals rate cuts ahead, bond yields could fall quickly – temporarily widening the spread and giving well-positioned buyers a window to lock in higher yields before property values adjust upward.

Credit Market Stress and Distressed Opportunities

One of the clearest signs of bond market impact on CRE is unfolding in the credit markets. As high interest rates strain borrowers, we are seeing cracks in commercial mortgage-backed securities (CMBS) and other real estate debt. Notably, some single-asset/single-borrower (SASB) CMBS deals tied to marquee office properties have slipped into default in the last couple of years, even those issued at the height of the market in 2021. The jump in bond yields and a shift in office demand (due to remote work) left these properties unable to refinance or service debt, demonstrating how quickly conditions can change. The distress isn’t limited to offices – across the board, higher benchmark rates have reduced loan proceeds and increased refinancing costs for retail, hotel, and even multifamily owners. For investors, this turmoil in the bond-financed part of the market is both a warning sign and a potential opportunity. We’re now witnessing a surge of interest from opportunistic funds targeting distressed real estate debt. Wall Street institutions and private equity firms have raised tens of billions in “rescue capital” to snap up defaulted loans and discounted CMBS bonds linked to properties (The Real Deal – Hedge Fund Hunting for Distressed Property Debt (Oct 2024)). Their bet: by purchasing troubled mortgages at a steep discount (owing to high yields and price drops), they can profit when either the borrower restructures or the asset is ultimately sold. For the broader market, this wave of distressed-debt investing may help establish a floor – it means there’s capital waiting in the wings to buy loans or assets once valuations reset low enough. Nevertheless, the fact that even senior, highly rated CRE bonds have taken losses underscores the bond market’s impact. Rising yields can swiftly turn a “safe” bond into a risky proposition, so CRE investors should keep one eye on credit spreads and lender sentiment as part of their bond-market vigil.

Regulatory and Capital Stack Considerations

Finally, rapid changes in interest rates bring a host of technical considerations for deal structuring, taxes, and regulations. Investors must consider how rising or falling bond yields affect each layer of the capital stack. For instance, in a low-rate environment, borrowers often pile on cheap debt (increasing leverage with mezzanine loans or preferred equity) to boost returns. But when rates spike, that high leverage can become untenable – debt service coverage shrinks and some borrowers may violate loan covenants or face refinancing shortfalls. Lenders respond by tightening loan-to-value ratios and requiring more equity, which shifts how deals are financed. Another consideration is prepayment penalties on existing loans: many fixed-rate commercial mortgages include yield maintenance or defeasance clauses, meaning if an owner sells or refinances early, they owe a penalty designed to make bond investors whole. When prevailing yields have risen above a loan’s coupon rate, those prepayment penalties often decline (or even disappear), potentially creating an incentive for borrowers to sell or refinance sooner than planned. Conversely, if rates drop far below an existing loan’s rate, getting out of that loan can be prohibitively expensive. Tax-wise, the interest rate environment can influence strategies like cost segregation and depreciation timing. In high-rate periods, the interest expense (being higher) provides a bigger tax shield, while in low-rate periods investors might focus more on accelerating depreciation to shelter income. Moreover, policymakers are not oblivious to bond market impacts: sustained high Treasury yields can prompt regulatory scrutiny of bank real estate exposures or lead to changes in tax incentives to stimulate investment. In sum, CRE players need to be nimble – as the bond market resets the cost of capital, successful investors adapt their financing strategies, deal structures, and exit plans to stay ahead of the curve.

Frequently Asked Questions (FAQs)

How do Treasury yields directly affect mortgage rates? – Long-term mortgage rates (including commercial mortgages) are closely tied to the 10-year Treasury yield. Lenders use the 10-year Treasury as a benchmark and then add a credit spread to arrive at the mortgage rate. Thus, when the 10-year Treasury yield moves up, most fixed mortgage rates also rise; when it falls, borrowing costs tend to come down. In fact, the 30-year residential mortgage is basically “benchmarked” to the 10-year U.S. Treasury note, as confirmed by Fannie Mae’s research, which shows mortgage rates generally follow suit with 10-year yield movements (Fannie Mae – What Determines the Rate on a 30-Year Mortgage?).
Why isn’t the Fed’s rate policy as important to CRE? – The Federal Reserve sets short-term interest rates (like the overnight interbank rate), which influence things like bank prime rates and short-term loans. However, commercial real estate investments are typically long-horizon and often financed with medium- to long-term debt. It’s the bond market – investors’ collective outlook on inflation, economic growth, and credit risk – that determines longer-term rates such as the 10-year Treasury yield. That yield, in turn, has a far more direct impact on cap rates and the interest rates for 10-year loans than the Fed’s month-to-month rate tweaks. In essence, the Fed can nudge the rudder for short-term rates, but the ocean swell that CRE ships ultimately ride on is the long-term bond market. This was evident in late 2024: even after the Fed began cutting rates, 10-year Treasury yields kept climbing due to inflation expectations, and mortgage rates actually went up, not down – a reminder that bond traders’ expectations trump the Fed’s actions when it comes to long-term financing costs.
Can cap rates ever go down when Treasury yields are going up? – Yes, it has happened during certain periods. Cap rates are not purely mechanical reflections of Treasury yields; they also incorporate growth expectations and capital flows. If investors anticipate strong rent growth or if there is a flood of capital eager to buy real estate, cap rates can continue to compress (i.e. property values rise) even in the face of rising bond yields. A historical example: in the mid-2000s, despite the Fed raising rates and higher Treasury yields, cap rates in sectors like multifamily and industrial actually declined because real estate fundamentals and investor demand were extremely strong. Such scenarios aren’t the norm, but they illustrate that other factors (like optimism about income growth or simply too much investment capital chasing deals) can, at least for a time, outweigh an upward shift in the risk-free rate. Over the long term, however, sustained divergence is rare – if interest rates remain elevated, eventually cap rates tend to catch up unless extraordinary growth materializes to justify lower yields.
What specific yields or indicators should CRE investors monitor? – The 10-year U.S. Treasury yield is the headline metric to watch, as it anchors most commercial mortgage rates and investment return models. Additionally, savvy investors keep an eye on the yield curve (the spread between short-term rates and long-term rates). For example, an inverted yield curve (short-term rates higher than long-term) might signal a coming recession, which could impact occupancy and rents. Beyond government bonds, look at credit spreads in the corporate bond market and CMBS market: if those spreads are widening, it means lenders and bond investors are growing more risk-averse, which can presage tighter lending conditions for real estate. Many professionals also monitor indices like the BBB corporate bond yield (as a proxy for the cost of capital for leveraged investments) and CMBS yields or spreads for real-time signs of stress in commercial real estate lending. In short, it’s wise to track both the absolute level of Treasury rates and the extra yield investors demand for taking on risk in real estate.
How can CRE investors hedge against interest rate swings? – There are a few strategies to manage interest rate risk in a property portfolio. One common approach is to balance your debt structure between fixed-rate and floating-rate loans. Using fixed-rate financing locks in today’s rates and insulates you if bond yields rise further. Floating-rate loans (often tied to short-term benchmarks like SOFR) might offer savings if rates fall, and their interest can be capped with derivatives. Many large investors use interest rate swaps or purchase rate caps to put an upper limit on their floating loan rates. Another tactic is to invest in assets or lease structures that naturally adjust to inflation – for example, multifamily or self-storage properties where rents can be raised relatively quickly, or leases with built-in escalation clauses – these can act as a hedge because higher inflation and rates often go hand-in-hand. Finally, some investors allocate a portion of their portfolio to sectors less sensitive to interest rate changes or even to fixed-income investments themselves, creating an internal hedge. The bottom line is diversification and proactive financial management: by not betting the farm on any single rate scenario, you can weather the storm of rising or falling yields.

Ultimately, the message for commercial real estate players is clear: to navigate this industry successfully, one must be as attuned to the bond market as to the property market. The Fed’s overnight rate might grab headlines, but it’s the 10-year Treasury yield and its kin that quietly dictate the financial currents in which CRE values float. A property’s cap rate, an investor’s ability to secure financing, the pricing of loans and the appetite of global capital – all these are shaped by what’s happening in bonds. By keeping a close watch on Treasury yields and credit spreads, investors can anticipate shifts in cap rates and property values rather than just react to them.

Actionable takeaways for stakeholders: it’s wise to build bond market vigilance into your routine. Track the 10-year yield on a daily or weekly basis, even if your focus is on leasing a building or negotiating a sale – it will provide context for the offers you receive or the bids you make. Incorporate interest rate scenario analysis in your quarterly portfolio reviews: ask, “If base rates rise or fall by 50 basis points, how does that impact our refinance prospects or exit cap rates?” And position your portfolio and financing mix to be resilient under different rate environments – for example, maintain some dry powder or low-leverage positions to capitalize on high-rate opportunities, and consider locking in fixed debt when rates are historically low. In an industry as capital-intensive as real estate, those who master the interplay between the bond market and CRE will consistently make more informed decisions.