The question is one of great debate, though it would seem that rising long term interest rates will have some measurable impact on cap rates and real estate values. The Fed raised its Fed Funds short term rate at its last meeting, which is how it generally addresses interest rates and its influence on the job market and inflation. US short term rates were kept at historically and artificially low rates since the financial crisis in 2009 in an effort to stabilize the economy and have it recover. In a desperate attempt to accelerate the recovery, the Fed then started its massive bond purchase program which also dramatically lowered long term interest rates, a move it had never before undertaken. Now the Fed is in the process of normalizing the short term Feds Fund rate and unwinding its massive bond holdings on its balance sheet, so the combined effect of this is expected to be continued rising short term rates and long term rates over the next few years. Most experts expect, perhaps, another 200-250 bps increase in both short term and long term rates but to be felt gradually over the next couple of years. Many real estate industry experts believe there has to be some impact of increased long term rates on real estate values and cap rates (and a more direct impact than the short term Fed Funds rate increases), but long term rates are market driven and not controlled directly by the Fed, so those increases are harder to predict and often are driven by emotional reactions to perceptions of inflationary pressures and the potential of the economy or labor market overheating. In addition, there is not a direct correlation between increased long term rates, upon which real estate borrowing costs are based, and real estate cap rates. However, since return rates are very much affected by the cost of long term borrowing, there will be some impact on valuations and cap rates for real estate from increased long term interest rates. Most experts do not expect the correlation to be anywhere near 1:1 on cap rates, but it is hard to imagine that the affect will be minimal and historically there has been a material correlation, but since cap rates also are influenced by other factors, such as a stronger economy leading to stronger demand and increasing rents, interest rates are not the only factor in capitalization rates.
