Leveraging value: Unveiling the cap rate dynamics in U.S. office building financing

The relationship between cap rates and average loan-to-value (LTV) ratios reveal a lot as it relates to investor sentiment and perceived risk toward acquiring office assets.
In the wake of interest rate hikes, U.S. 10-year treasury yields have spiked correlating to the increased costs of borrowing. That said, cap rates for office trades have also increased, as yields need to reflect the risk premium toward acquiring an office building versus buying a virtually risk-free U.S. treasury bond.
The average LTV ratio falling over time is another reflection of perceived risk—this time on the part of lending institutions—who are now requiring borrowers to inject more equity into deals to make them pencil and create value for all parties.
As return-to-office initiatives and the macroeconomic climate stabilize, the future of office trades remains uncertain. While the markets evolution will be interesting to monitor, potential buyers may find it difficult to justify putting 50% equity into trades, considering the record-high lease-up costs associated with office buildings, such as tenant improvements and commissions.

May 30, 2024