The graph below has been prepared using Real Capital Analytics data, along with data on the yield of the 10 year treasury note.
One of my favorite themes that I come back to over and over again is certainty. Or maybe, a better way to say it is our overconfidence in our own feeling of certainty. As I prepared the graph below, I couldn’t help but think about certainty again. The graph shows average CRE cap rates versus the 10 year treasury note. The place where “certainty” becomes a really prominent theme is in the 2005 to 2006 time frame, when CRE yields are a little less than 200 basis points over the 10 year Treasury.
That’s insane – albeit, in hindsight – with a healthy amount of Monday morning quarterbacking.
However, viewing the data with the benefit of hindsight does show that markets work exactly the opposite way that you would expect them to, if you believe in efficient markets. We know that the times that were perceived as being high risk, and thus justifying high yield spreads, were exactly the opposite of that. At the same time, the periods of low perception of risk where CRE yields were trading at only a very slight markup over Treasury debt were exactly the opposite.
So what causes us to put all of our money into the market at exactly the wrong time? If investing is a series of risk adjusted bets, why do we regularly make wild misjudgments of actual risk? Given our own history of wild misjudgments of the market, why don’t we learn any humility?
If hubris is the opposite of humility, then CRE yield spreads 150 bps over the 10 year Treasury have to be really close to the definition of hubris. Even more amazing: that’s the average cap rate reported by Real Capital Analytics. Which means that about half of the money put into the market at that time cleared at a spread of less than 150 bps!!!
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