Speculating Vs. Investing in Real Estate -- Analyze Short- and Long-Term Equally

My younger brother has a friend who just started a job at a nationwide real estate brokerage firm after graduating from college back in May. He called me last weekend and asked me a very good question about US treasury yields and I wanted to address here.

I am sure a lot of you have noticed the yields on US treasuries have been plummeting. I won't get into why that is right now, but let's just focus on the fact that the 10 year treasury is, at the time of this writing, at 1.935%. My brother's friend said he's being told that entry into the real estate world now is a great buy opportunity because the gap between CAP rates (the yield on real estate) and the yields on these investments is so much bigger now than it has been in the last couple of years. This is 100% true and it's a good thing to look at when looking at real estate investments. 

However, he was smart and asked, "Yeah, but what about when the spreads become smaller because the treasury yields increase back to normal rates again? Unless you're holding forever, this could end up hurting you since most people hold for less than 10 years and treasury yields will almost definitely go back up and it will go up a lot."

Yep! Correct! Here is a guy who just started in real estate a few months ago, but he didn't overthink anything. He just thought logically. Once yields go back up, CAP rates will go back up again and you may still have good debt levels for now, but rarely do commercial real estate buyers lock in their rates for 30 years. Usually it's for 10 years. So you have to hope that in 10 years, the spreads don't get out of control and you're stuck in a refinance position that could be trouble.  

If you look at the 10-year yield over the last 5 years, it has been wild! It has been as low as 1.935% and as high as 5.11%, which is a large difference.  (http://www.economagic.com/em-cgi/data.exe/fedbog/tcm10y:%28rev%29)

This is a prime example of making decisions on short term info and not looking at the repurcussions of what can easily happen down the road. The thought of the 10-year going up 4% or 5% in the next few years is not something that hasn't happened or a place we haven't been to. We are there regularly. But ignoring that can cost you money unless you are locking rates in for long periods of time (20+ years) where you can raise rents on your property and have inflation help your property value and rents. This young man is looking at it the right way. He isn't speculating…he is investing. He is looking at the picture from the short AND long term and not getting caught up in today.