Property Vclues Hcve Fcllen Signifccntly hisCycle Despite Continued Economic Growth
Peak to Trough* NCREIF Property Index Value Change (%)

0-Æ.Ä㔀
㔀0㔀-17.9㔀0㔀㔀0-3¼.º-32.3

㔀Early 1990s

Dot-com Bust

GFC

Current

Source: NCREIF Property Index (Classic), Roofstock Research* Current cycle is being measured through 2024Q1

While not as severe as the early 1990s and Global
Financial Crisis (GFC), where values declined by morethan 30%, the drop in value this cycle has beensignifcant given the strong economic and employment
backdrop. This would seem to suggest that values may
be on sale and that it is a good time to invest, butinterest rate trends and relative yields tell a different
story. The three prior value cycles came to an end aided
by accommodative monetary policy and a favorable
interest rate environment. The Fed Funds rate wasreduced by an average of 300 basis points in those
three cycles, as the Fed moved to improve liquidity,
stem the decline in asset values, and encourage
growth. So far in this cycle the Fed Funds rate has
increased by 450 basis points. The Fed remains much
more restrictive today than it was at the peak ofproperty values in 2022.

Similarly, the interest rate on the 10-Year was lower or fat from the peak to trough in values in the three prior cycles.
In the frst quarter of 2024, the 10-Year was over 120 basis points higher than it was in mid-2022. higher so-called“risk-free” rate implies that, all-else being equal, real estate investors should be seeking even higher yields on theirinvestments to compensate them for risk. The higher prevailing interest rate environment also has knock-on effects
for borrowers as the higher cost and lower availability of debt make it harder to buy new properties and refnanceexisting ones.
ut more specifc to our relative yield discussion, what happened to the spread between current value cap rates andthe 10-Year in each of these cycles? In the chart on the following page, we see that this spread increased in the priorthree cycles, making real estate look more attractive on a relative basis, while the spread this cycle has decreasedfrom 2022 to today. y this measure, real estate looks less attractive today (the spread is lower) than it did at thepeak.
In absolute terms, the contrast in relative yield is even more stark. The current value cap rate spread over the 10Year averaged nearly 340 basis points during the Early 1990s, Dot-com ust, and GFC cycles. This sizable spreadhelped draw in new capital and put a foor under values, setting the stage for future value growth. y comparison,
the spread in the frst quarter of 2024 was less than 50 basis points with the current value cap rate at 4.63% and the
10-Year averaging 4.16%. Not only is this a tight spread versus past cycle value troughs, it is also very tight for an
asset class that has offered a 265 basis point spread over the 10-Year for the past 30 years. Real estate looks more
expensive today than it has historically, and it is much more expensive on a relative basis in comparison to the value
troughs of the prior three cycles.

© 2024 Roofstock Inc.

2NCREIF data offer another perspective on values basedon relative yields and that is derived from a comparisonof transactionnbased cap rates looking at the relatively
small sample of properties sold from the index eachperiod and the current value cap rate of the assets heldin the portfolio. We do not want to overstate theprecision of this comparison since the property sector
and asset quality composition of sales in each period
can signifcantly impact transactionnbased cap rates inthis small sample. Still, the spread between the two
metrics is directionally instructive. These data tell usthat properties are transacting at higher cap rates thanbook value would imply. The good news here is thatproperties can be acquired today at cap rates that are
accretive to current portfolio yields.
This condition has been true over history withtransactionnbased cap rates running about  basis
points over current value cap rates for the past Eyears. We have also seen that this spread tends to beeven wider at cyclical value troughs. But today
transactionnbased cap rates are over A basis points
higher than current value cap rates, the widest spreadsince the third quarter of A##.  pessimistic view here
would be that the value of held portfolios is more
expensive today versus the transaction market than it
typically has been. This is another signal that appraisal
values may be too high.
Relative yield is just one part of the value story, and weare painting with broad strokes by looking at overall NItrends. roperty sector allocations, asset quality, andvaluation processes are different from one portfolio tothe next. ields are undoubtedly more attractive andbetter supported in some property sectors andportfolios than others, although none of the major
property sectors look attractively valued today versus
past cycles.
The offce property sector has the highest spread
between current value cap rate and the Anear at Abasis points as of the frst quarter of , but its
spread averaged nearly E basis points at the trough© 2024 Roofstock Inc.

But Current Conditions Suggest Values May
Fall Further
Basis Points

52545375
3225
1575-75-15-225-3-375
Peak to TroughFed Funds Rate
ChangeEarly 1990s

Peak to Trough10-Yr. Treasury
Rate ChangePeak to Trough
Change Ln Cap Rate
to 10-Year Spread

Dot-com Bust

GFCTrough Cap
Rate to 10-Year
SpreadCurrent

Source: NCREIF Property Index (Classic), Roofstock Research,Federal Reserve, Moody’s Analytics* Current cycle is being measured through 2024Q1

High Transaction Cap Rates Vs. Current Value
Cap Rates Signal Either A Buying Opportunity
Or Risk Of Depreciation
Transaction Cap Rate to Current Value Cap Rate
Spread at Trough (bps)
111
1
100

Early 1990s

Dot-com Bust

GFC

Current

Source: NCREIF Property Index (Classic), Roofstock Research* Current cycle is being measured through 2024Q1

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of the previous three cycles and given the sector’sheightened uncertainty due to changes in space
utilization, it seems clear that offce values have further
to fallt Apartment and industrial assets in the NPI are
held at current value cap rates in the low T%-range
offering, essentially no spread versus reasuriest
Fundamentals in these sectors are unquestionably
stronger than offce, but these holdings face valuation
headwinds as wellt.
We will have more to share on single-family rental’s(SFR’s) role in a diversifed portfolio in a future report,
but this is a good moment to highlight that we expect
SFR to enjoy strong tailwinds as demographics andaffordability issues lead to more households seeking torent single-family homest he property sector is alsomaterially undersupplied, setting the stage for healthy
NOI growtht Additionally, even in this reduced homesales environment, there is much more clarity aroundproperty values in SFR than there is in the commercial
property sectorst ransaction cap rates are similar to
those in multifamily with fewer near-term supply
headwinds and a more robust demand storyt
Institutions also own very little of this property sector,
with exposure equal to less than 0t5% of holdings inthe broader NPI universe, creating benefts from future
capital infows and opportunities to improve portfolio
diversifcationt.
Commercial property investors taking a bullish stanceon rent and NOI growth driven by strong underlying
economic conditions and reduced construction starts,
along with expectations for the Fed to begin cutting
rates later this year, may feel comfortable justifying
tight current value cap rate spreadst In our assessment

Questions? Please contact:
Paul Briggs, CRE
Head of Research & Investment Strategies
paul.briggs@roofstock.com

such positive perspectives may be too optimistic or atthe very least fraught with considerable levels of riskt
While recession probabilities remain low, around 25%
per oody’s Analytics and Oxford èconomics, the risk
has ticked higher as tight monetary policy continues tofow through the economyt onetary policy changes
take time to unfold, and the same will be true when theFed eventually begins to lower interest ratest he silverlining here is the Fed does have plenty of room toreduce rates if the economic environment deterioratest
But it is not clear that the long end of the interest rate
curve will follow short-term interest rates lower inlockstep given the current inversion in the yield curvet.
Second quarter NPI values may refect stability andperhaps even a gain, but it is diffcult to envision aconcerted, material rise in property values given
relative yields todayt aking matters worse, interest
rates were higher in the second quarter than they werein the frstt he lack of a recession has been asignifcant counterweight to yield pressurest If a
recession does occur, the downside risk is material withvalue losses from the 2022 peak potentially exceeding
the ·0%¶ declines of the èarly µÉÉ0s and ÓFCt.
Investors with capital to deploy today on newacquisitions certainly have the opportunity tooutperform the NPI benchmark as the book values oflegacy assets slowly mark to markett But even theseinvestors should carefully monitor downside risks andgive strong consideration to property sectors withfavorable supply and demand outlooks and, in thecase of SFR, a sector where asset values are
predominantly infuenced by the housing needs anddesires of individual owner-occupiers and not relative
cap rate levelstäThis information is intended for educational purposes only and is
not fnancial, investment, legal, or taa advice. Roofstock is notyour advisor or agent. Please consult your own advisor forguidance. Although Roofstock provides information it believes tobe accurate, Roofstock makes no representations or warranties
about the accuracy or completeness of the information containedin this article.

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