The research firm says an overvaluation of the bond market will cause U.S. office building prices to fall by 40% by the end of next year

• According to Capital Economics, an increase in bond yields may cause a collapse in prices in the office sector.
• This is because rising Treasury bond yields may impact office building capitalization rates, driving down prices.
• The company forecasts that office prices could fall 40% from peak to trough by the end of next year.

According to Capital Economics, rising bond yields will reduce US office real estate prices by as much as 40% by the end of next year.

The research firm highlighted the recent increase in Treasury yields, with the 10-year bond yield recently hitting 5% for the first time since 2007.

The 10-year bond yield could fall to about 3.75% in 2024 and then rise again to 4% in 2025, the company predicted in a note Tuesday.

This is likely because the neutral real interest rate, which is an interest rate that neither increases nor contracts, is likely higher than it used to be, which means overall bond yields will remain higher in the long run.

Higher bond yields drive higher interest rates throughout the economy. In the commercial real estate space, this may mean higher capitalization rates or the expected return on the income generated by the property.

Like bond yields, cap rates are inversely related to real estate prices, which means higher cap rates will cause prices to fall.

“Due to upward revisions to our 10-year Treasury yield forecasts, we now expect greater increases in yields,” said Capital Economics deputy chief real estate economist Kiran Raichura. “At the level of all real estate, this will mean an increase in capitalization rates by almost another 100 basis points, up to a maximum level of approximately 5.2%, which will result in a decline in total value of more than 20%,” he added, referring to the entire real estate sector.

Raichura predicts that office capitalization rates could rise to 6.5% by the end of 2024, which could result in office prices falling by at least 40% on a maximum basis. This reflects a steeper decline than his previous forecast, which saw prices fall 35% by the end of 2025.

Experts have been warning of problems for the commercial real estate sector since the banking turmoil in early 2023 resulted in tighter lending conditions. Banks are less willing to lend to risky, illiquid commercial real estate assets, and property owners who are able to refinance their mortgages must do so at much higher interest rates.

Experts warn that this dynamic could trigger a wave of unrest as the sector comes due on about $1.5 trillion in debt over the next few years.