How Interest Rates Affect Cap Rates: Spreads and Lags

Interest rates affect cap rates through two channels: investors price property as a spread over the yield on safe bonds such as the 10-year Treasury, and the cost of debt limits what buyers who borrow can pay. When rates rise, cap rates tend to rise and values fall, but the link is loose and arrives with a lag. Treat the 10-year as pressure on cap rates, not a formula for them. Owners get hurt when a refinancing plan depends on the formula working in their favor.

Two channels from rates to cap rates

Required return. A cap rate is net operating income divided by value. For a stabilized asset it approximates the investor’s required return minus expected NOI growth, and the required return is a risk-free rate plus a risk premium:

Cap rate ≈ risk-free rate + risk premium − expected NOI growth

When the risk-free rate rises and nothing else moves, the cap rate rises by the same amount. Something else usually moves.

Illustrative example: the same $1,000,000 of NOI under three rate scenarios

In the third column, faster expected rent growth and a thinner premium absorb the rate move, and the cap rate stays put. That is how the relationship goes loose.

Cost of debt. Most buyers borrow, and lenders size loans on debt service coverage and debt yield. A higher mortgage rate raises debt service on the same loan, so DSCR-constrained proceeds fall, the same equity buys less property, and bids come down. The rate that matters is the all-in borrowing rate: a Treasury or swap rate plus a lender spread that moves on its own schedule.

Cap rates versus the 10-year Treasury

The cap rate spread is the cap rate minus the 10-year Treasury yield. It prices property risk and growth over a safe bond, and it decides how much of a rate move values can absorb. The Federal Reserve tracks a version of it: its November 2022 Financial Stability Report describes the spread of cap rates to real (inflation-adjusted) Treasury yields as a measure of risk appetite in commercial real estate, and noted that it remained in the bottom third of its historical distribution through August 2022.

A thin spread leaves little room. Take a property at a 5.50% cap rate with the 10-year at 4.00%, a 150 basis point spread, and $1,000,000 of NOI worth $18,181,818.

• The 10-year rises to 5.00% and the spread holds at 150 basis points: the cap rate goes to 6.50%, value to $15,384,615, down 15.4%.
• The 10-year rises to 5.00% and the spread compresses to 100 basis points: the cap rate goes to 6.00%, value to $16,666,667, down 8.3%.

If the spread widens instead, values fall further than the Treasury move alone implies. The spread is a market output, not a constant, so no fixed rule converts a Treasury move into a cap rate move.

Why the relationship is loose and lagged

The last cycle shows the lag. The 10-year Treasury yield closed at 0.52% on August 4, 2020, and at 1.63% on January 3, 2022 (FRED, DGS10). The FOMC raised the federal funds target range to 1/4 to 1/2 percent on March 16, 2022, and the 10-year reached 4.25% on October 24, 2022.

Cap rates did not follow in real time. In November 2022 the Fed reported that cap rates at the time of purchase “continued to decline and were at historical lows,” even as price increases slowed sharply, partly in response to higher borrowing costs. Only in May 2023 did it report that cap rates had “turned up modestly from their historically low levels.” The Fed’s series is a 12-month moving average, which smooths and delays the turn, so part of the lag is in the measurement itself. The 10-year closed at 4.98% on October 19, 2023. By November 2025 the Fed described inflation-adjusted CRE prices as stabilizing after significant declines between mid-2022 and early 2024, with cap rates still below the average of their historical distribution.

The mechanics behind the lag:

• Cap rates come from transactions. When bids fall and sellers hold, fewer deals close, and those that do still clear near old prices.
• In-place fixed-rate debt lets owners wait. A low coupon with years to maturity removes any reason to sell into a weak bid.
• Appraisals look backward. Comparable sales reflect the market months earlier.
• Growth expectations move too. Rent growth that accompanies inflation offsets part of a rate increase.
• Credit conditions move separately. Lender spreads and appetite change independently of the Treasury.

Maturities end the waiting. A loan that comes due forces the price discovery an owner could otherwise postpone.

Negative leverage

Negative leverage is the condition in which the cost of debt exceeds the property’s unlevered yield, so every dollar borrowed lowers the return on equity. It often appears when cap rates lag a rise in borrowing costs.

Illustrative example: a $20,000,000 purchase at a 5.50% cap rate, 60% loan-to-cost, interest-only

At 4.50% the debt adds 150 basis points to the equity return; at 6.50% it subtracts 150. On an amortizing loan, compare the cap rate with the loan constant (annual debt service divided by the loan), not the note rate, because principal is also paid from NOI. Buyers accept that trade when they expect NOI growth or cap rate compression to close the gap. When neither arrives, the equity return stays below the unlevered yield for the life of the loan.

What it means for refinancing and valuations

At refinancing, rising cap rates arrive through value, and value sets loan-to-value proceeds.

Illustrative example: a loan originated at a 4.50% cap rate and refinanced at 6.00%, NOI unchanged, interest-only

The lender funds the lowest constraint, here $9,750,000 on loan-to-value; a DSCR test at the new rate can bind first. The existing loan’s debt yield is $900,000 ÷ $13,000,000 = 6.92%, below the 9.0% test at any cap rate, because debt yield ignores value entirely. Lower cap rates would restore LTV proceeds and leave that constraint unchanged.

For valuations, the exit cap assumption carries the same sensitivity. On $900,000 of NOI, a 5.75% exit cap gives $15,652,174, 6.00% gives $15,000,000 and 6.25% gives $14,400,000: $600,000 to $652,174 of value per 25 basis points. Show committee the range, not the midpoint; see loan-level valuations for investment committee. For floating-rate loans, the rate path to the maturity date comes from the SOFR forward curve, and the full process is in our guide to commercial real estate refinance.

What to track

• Value of every property with a loan maturing within 36 months, at today’s cap rate and 50 and 100 basis points higher.
• Refinancing proceeds under LTV, debt yield and DSCR at today’s rates, and the equity gap per loan and per year.
• The spread between your marks and the 10-year Treasury, with dates.
• Cap rate against loan constant on every acquisition and refinancing.
• Hypothetical DSCR tests keyed to Treasury plus spread, which move with Treasury yields even when the loan is fixed.

How this looks in LoanBoss

Valuations sit beside compliance and reporting as one of LoanBoss’s three solution areas. Live rates, loan abstracts and accounting feeds refresh balances, DSCR and cash flows automatically, and each lender’s DSCR and debt yield test runs on its own definition, including greater-of tests that compare the in-place rate with Treasury plus spread. One customer describes running scenarios at the touch of a button for hold/sell analysis at investment committee. The cap rate stays the owner’s assumption; LoanBoss keeps the loan side of that analysis current.

Frequently Asked Questions

Key takeaways

• Rates push on cap rates through required returns and through the cost of debt.
• The spread to the 10-year absorbs or amplifies rate moves; no fixed ratio links the two.
• Cap rates were at historical lows in the Fed’s November 2022 report and had turned up only modestly by May 2023.
• When borrowing costs exceed the cap rate, debt lowers the equity return instead of raising it.
• Refinancing ends the lag: model value at today’s cap rate and the equity gap per loan.

Related reading

• The 2026 maturity wall: a data-driven update
• The maturity wall refinancing playbook
• Portfolio cash flow projections and hold/sell scenarios
• Loan portfolio dashboards with real-time rates
• Net operating income in the glossary

The Treasury moves every day and the cap rate catches up when a loan comes due. LoanBoss shows you which loans come due first.