C&W Sees Manageable Treasury Outlook for CRE
Commercial real estate investors hoping for a steep decline in Treasury yields should be cautious. Lower yields would reduce borrowing costs, but Cushman & Wakefield argues that a rapid move lower could signal a recession or another economic shock. The firm sees the most likely outcome as one in which the economy continues to grow and Treasury yields either ease gradually or remain near current levels. Those two outcomes carry a combined 75% probability in Cushman’s 12-month outlook, according to Kevin Thorpe, the firm’s chief economist. The message for investors is straightforward: Do not build an acquisition strategy around the expectation of dramatically cheaper debt. Underwrite to today’s financing environment, and treat any meaningful rate decline as upside.
The Case For Moderate Rates
Thorpe assigns a 50% probability to what he calls gradual normalization, with the 10-year Treasury yield settling in a range of 4.25% to 4.50%. That would be the most favorable outcome for commercial real estate, according to Cushman. Inflation would continue to moderate while the economy expanded, allowing borrowing costs to ease without the deterioration in demand that could accompany a recession. For property investors, that mix could bring greater pricing certainty and improved debt-service coverage. Limited new construction, combined with improving property fundamentals, could support more transaction volume and modest cap-rate compression.
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Cushman assigns another 25% probability to a scenario in which the 10-year Treasury remains near 4.8% while the economy continues growing. Debt would remain expensive and investors should not expect significant cap-rate compression. Still, stronger leasing demand and NOI growth could offset part of the financing pressure, while transactions could remain healthy as buyers and sellers adjust to the rate environment. Together, those scenarios suggest that commercial real estate does not necessarily need a return to much lower rates to continue its recovery. What matters more is whether the economy can support occupier demand, rent growth and property cash flow.
Why The Cause Matters
The 10-year Treasury yield rose from just below 4% in late February to about 4.8% in early September. Over the same period, the five-year Treasury increased from roughly 3.5% to 4.5%. Conventional secured commercial real estate mortgage rates rose more modestly, from about 6.2% to 6.5%. The increase is clearly a headwind. Higher Treasury yields increase financing costs, push up required returns and place upward pressure on capitalization rates. But Thorpe’s analysis emphasizes that investors should pay as much attention to why yields are moving as to where they land.
A 4.8% 10-year yield driven by renewed inflation or concerns about the federal fiscal outlook would be negative for commercial real estate. It would raise financing costs without providing much offsetting support for tenant demand or operating income. The same yield in an economy growing faster than expected presents a more balanced picture. Stronger employment, business investment and leasing activity can support rents and NOI, helping properties absorb some of the pressure from higher debt costs.
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Cushman’s analysis also suggests that inflation expectations are not the main driver of the recent increase. Of the roughly 80-basis-point rise in the 10-year Treasury since February, Thorpe attributes about 10 basis points to inflation expectations, 50 basis points to higher expected real short-term rates and 15 basis points to a higher term premium.
The Risks At Both Ends
The more challenging outcomes in Cushman’s forecast are less likely, but they carry clearer risks for commercial real estate. Thorpe assigns a 15% probability to the 10-year Treasury moving solidly above 5%. That could occur if inflation reaccelerates, fiscal concerns intensify or the term premium rises further. A sustained move above 5% would increase refinancing pressure, slow transaction activity and potentially stall or reverse the recovery in property values. At the other end of the range, Cushman gives a 10% probability to the 10-year Treasury falling below 4%.
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While that would lower borrowing costs, the firm views it as the least favorable signal for the broader economy. A quick drop in yields would likely reflect a recession, labor-market weakness, a significant equity or AI-related market correction or another shock that drives investors into safe-haven assets. In that environment, weaker leasing demand and lower expectations for NOI could outweigh much of the benefit from cheaper debt. For commercial real estate, then, a lower Treasury yield is not automatically a better Treasury yield. Investors may welcome lower debt costs, but the source of that relief matters.
What Investors Should Underwrite
Cushman’s conclusion is that investors should avoid making sharply lower rates a requirement for a deal to work. Instead, acquisitions should be underwritten using current financing conditions. A decline in rates can provide upside, but it should not be the foundation of projected returns. That is particularly important for assets whose investment case depends heavily on cap-rate compression. The more resilient opportunities may be properties with stable or rising NOI, credible value-add potential and cash-flow growth that does not rely on a major change in capital markets. Those characteristics could help investors handle either of Cushman’s more likely scenarios: gradual rate normalization or an extended period of raised but manageable Treasury yields. The key question is not simply whether the 10-year Treasury falls. It is whether the economic conditions behind its movement support the tenants, rents and operating income that ultimately determine commercial real estate performance.
