A “modest” growth in REITs cap rates is expected due to high interest rates - Baird

Baird analysts expect modest growth in the real estate market’s cap rates with slow net lease activity and high volatility as deals wait for interest rates to fall.

In an Equity Research Morning Report, analysts said cap rates -- a property's net operating income divided by its asset value -- are “slowly grinding higher” in the fourth quarter and early in 2024.

Agree Realty Corp. (NYSE:ADC) is Baird’s top investing idea in the industry. Its current price is $57.19. Baird’s price target is $64, slightly reduced from a previous price target of $67.

“The relative valuation premium of Agree Realty Corp. (ADC) hit a multi-year low, and we believe is an attractive way to gain defensive exposure with potential upside from growth should interest rates moderate,” analysts said.

In addition, Alpine Income Property Trust Inc. (PINE) was moved to a higher risk rating, with a higher reward to invest in net lease. Company leverage is higher and visibility to scale the business is low, analysts said. “The offset is elevated asset recycling that includes buying shares at a meaningful discount to NAV (net asset value).”

Analysts explain that within the industry, visibility is low due to capital markets volatility. Both deals and competition remain low, which has led to a gradual rise in cap rates. The weighted-average acquisition yield for the REITs, however, increased 100 basis points last year, and 33 basis points quarter-over-quarter.

In addition, companies are expecting interest rates to fall, potentially slowing down deal volume and also slowing cap rates from increasing further.