Cap rate compression is not an anomaly. Between 2010 and 2022, yields on prime commercial real estate fell across every major market — from New York to Tokyo, from London to Sydney. The compression was not driven by improving asset fundamentals. It was driven by the cost of money.
Understanding why rates compressed, which asset classes compressed most, and what the post-2022 reversal means is essential for any investor currently underwriting a deal.
1. Why Cap Rates Fell from 2010 to 2022
The proximate cause was central bank policy. Following the 2008–2009 financial crisis, the Federal Reserve, ECB, and Bank of England kept base rates at or near historic lows for over a decade. This had two direct effects on property yields.
First, the risk-free rate fell, which mechanically reduced the spread required by investors for real estate exposure. Second, institutional capital — starved of yield in sovereign bonds — rotated aggressively into real assets. The result was sustained price appreciation without commensurate NOI growth, which compresses cap rates by definition.
By 2021, prime office cap rates in central London had touched 3.8%. Industrial assets in key US logistics markets were trading at 4.1%. Residential multi-family in Manhattan was underwritten at 3.2%. These were not yields that reflected operating fundamentals. They reflected a macro regime.
2. Which Asset Classes Compressed Most
Not all sectors compressed equally. The steepest compression occurred in assets where institutional demand was highest and supply was constrained:
- Prime logistics and distribution warehouses: compressed from 7.2% in 2012 to 3.9% by 2022
- Central London office: fell from 5.5% to 3.8% over the same period
- US multi-family residential: moved from 6.1% to 3.4% in gateway cities
- High-street retail: compressed initially, then reversed sharply post-2018 due to structural headwinds
- Secondary office markets: compressed but retained a 100–200 basis point premium over prime
3. The Rate Reversal Since 2022
The 2022 rate cycle changed the calculus fundamentally. As the Fed raised rates by 525 basis points in 18 months, the gap between cap rates and the risk-free rate inverted in many markets. Investors who had underwritten at 3.8% cap rates could now purchase 10-year treasuries at 4.5%. The required property premium disappeared, and prices adjusted.
Cap rate expansion has been most severe in the assets that compressed hardest. Office markets in the UK and US have seen expansions of 150–220 basis points. Industrial has partially unwound, with many markets now trading 80–120 basis points above 2022 lows. Multi-family has been slower to adjust due to structural housing demand.
4. How Cap Compression Affects Flip Returns and Stabilisation Premiums
Investors who purchased at compressed cap rates in 2020–2021 now face a two-sided problem. Exit cap rates on sale are wider, which reduces realised capital value. Simultaneously, refinancing at current rates strains debt service coverage ratios on assets underwritten for a 3.5% cap rate world.
The value-add premium — the spread between stabilised and unstabilised assets — has widened since 2022. Buyers now require greater compensation for renovation and lease-up risk. This widens spreads for disciplined investors who can execute, but increases entry requirements on deal underwriting.
Where is yield returning? Secondary logistics assets in non-gateway markets are pricing at 5.8–6.5%. Regional multi-family outside major gateway cities offers 5.5–6.2% in many US markets. Retail in high-footfall locations — which never compressed as deeply — is showing stabilisation at 7–8%.
The compression era is over. But the reversal does not mean value is everywhere. It means selective underwriting, cap rate sensitivity analysis, and conservative exit assumptions are no longer optional disciplines.