Understanding the Implications of SOFR and Treasury Yields

“The economy appears to be on track for a soft landing, although it may be bumpy throughout next year. In 2024, the multifamily market may see additional strain from high levels of new supply and continued high-interest rates but remains a favorable asset class given the state of the for-sale market and long-term demographic trends.”

- Sara Hoffmann, Director of Multifamily Research at Freddie Mac

Hi Nuvo Community,

_{Two critical indicators in this realm of multifamily real estate are the Secured Overnight Financing Rate (SOFR) and the Market Yield of a ten-year Treasury note (DGS10). This article delves into the correlation between these two rates and its implications for real estate investment decisions. SOFR, a measure of the cost of borrowing cash overnight collateralized by Treasury securities, is increasingly pivotal in the financial markets, often seen as a replacement for LIBOR. SOFR serves as a less speculative and less manipulable method for providing borrowing rates, relative to its predecessor, LIBOR. DGS10, the yield on a ten-year Treasury note, serves as a benchmark for mortgage rates and a barometer of long-term economic expectations. Both of these are key metrics within financial markets, having huge impacts on the movement within commercial real estate markets. Considering the consistent role SOFR is playing in multifamily real estate, being able to understand its movement is useful for anyone in the real estate space.}

_{Correlation Analysis: The Big Picture}

_{Our analysis reveals a strong positive correlation between SOFR and DGS10, indicating that movements in one tend to mirror the other. The correlation is approximately 0.86, a strong enough correlation to identify a relationship. It is important to note that due to the nature of the SOFR, it is usually slightly delayed in its movement. SOFR rates move very suddenly around bank deadlines as banks look to quickly acquire liquidity in US repo markets. If a 10-year yield falls, don’t expect SOFR to follow suit immediately. However, if we examine averaged SOFR rates, which tend to have a far smoother movement, we still find a similar relationship with ten-year yields.}

_{The time series chart above clearly illustrates the parallel trends of SOFR and DGS10 over time. This synchronized movement is pivotal for real estate investors, as it affects mortgage rates and, consequently, the cost of financing real estate investments. We see a few serious fluctuations in the SOFR that aren’t reflected in treasury yields, however.}

_{The year-over-year changes, seen in the time series above, while showing a more moderate correlation (0.54), suggest that short-term fluctuations in SOFR are slightly less reflective in DGS10 movements on an annual basis. SOFR is going to be vastly more temperamental than our Treasury note yields.}

_Conclusion

_{This analysis is limited in its scope, simply due to the lack of data. SOFR is a relatively new metric, and only recently officially supplanted LIBOR as the official standard in financial markets in June of this year. To confidently provide an analysis like this, we would want to examine a larger period, potentially being able to account for things like long-term market fluctuations or macroeconomic trends in the relationship. Being able to see how this correlation operates in a more traditional recession could potentially give us a lot of information.}

_{Implications For Multifamily}

_{By keeping an eye on the relationship between SOFR and DGS10, investors can make more informed decisions, understanding how movements in treasury yields will impact their future borrowing. Yields on Treasury notes give investors some sense of how the SOFR rates will be moving in the near future, and vice versa. But as treasury yields have just fallen dramatically from their recent highs, many are expecting SOFR to follow suit. SOFR may or may not move accordingly.}

Happy Real Estate!

All the best,

Yuri - Your Real Estate Investigator

Credit: Brian Underdahl, Chief Analytics Officer & Jackson Burks, Economic Analyst Intern

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