Economic Insights: Price vs. Value – Making Sense of Cap Rate Spreads in Shifting Markets

Written By National’s Head of Research and Analysis, Darob Malek-Madani 

Eighteen months ago, the real estate market was in the middle of a period of rising cap rates (and therefore falling values). In our blog post from early 2024, “The Wild World of Property Valuations: A Tale of Price vs. Value Cap Rates”, we examined a world where valuation cap rates across property types had risen nearly 1% while cap rates based on transaction data had risen 1.75%. Disproportionally, higher transaction rates appeared across sectors from the high-flying Industrial sector to the struggling Office sector, where the gap between transaction and valuation rates had grown to 75 bps and 175 bps, respectively. This large gap between valuation rates and transaction rates in early 2024 suggested that the market was not yet in equilibrium, and either property values would need to fall to match transactions in the market, or the transactions occurring in a volatile marketplace were not truly representative and future high-quality transactions would soon reflect valuation figures.  

Six quarters have passed since we first evaluated the gap between valuations and transaction cap rates, and the results are in: the gaps closed by about half in the industrial and office sectors, while holding steady in multifamily. A closer look at the data reveals a more nuanced story. In the Office market, valuation cap rates have fallen slightly (growing the gap), but transaction volume has increased substantially, and transaction cap rates have fallen rapidly, ultimately closing the gap. The Industrial sector, on the other hand, has had transaction cap rates holding steady while valuation cap rates have risen to meet them. For Apartments, cap rates have been flat all around, resulting in an unusually stable gap between valuation and transaction cap rates well above the historic average.  

Today, there is still a substantial gap between valuations and transaction prices across product types, but those gaps have closed in the sectors furthest from historic norms. Going forward, it appears there is still a disconnect (albeit smaller) between the price of commercial real estate being sold and the values held on institutions’ balance sheets. This gap may reflect investors’ continued uncertainty around inflation and interest rates, economic policy, and changing technologies around working and living. Going forward, it remains to be seen whether this gap will close further and if it does, whether it will come at the expense of rising market prices or falling appraisal values.