By Ryan McCullough, partner, managing director, Austin, Partners Real Estate
Dating back to mid-August, the 10-year Treasury yield rose about 65 basis points to 5.29 percent in early October before slipping back below 5 percent toward the end of the month. That move has widened the gap between how the Texas medical office market prices perceived safety and perceived risk.
Early in 2026, deals with perceived safety, such as those with national tenants on long-term leases, traded at staggeringly low cap rates that didn’t align with market debt. With all-in interest rates at 5.75 to 6.25 percent, we saw cap rates at or below those numbers. On market terms for amortization and down payment, the loan constant on that debt is close to 8 percent. The debt service could never meet coverage requirements, yet those deals kept trading.
Deals with perceived risk, such as those with short-term leases with local or regional tenants, traded in the mid-7-percent cap range. That pricing reflected current debt and the adjustments sellers needed to make to meet the market. Those cap rates have kept rising, and buyers are getting more aggressive in what they ask for.
Now debt has risen to nearly 7 percent, and perceived-safety pricing hasn’t moved. If anything, it may have compressed further. The result is a wide bid-ask spread across the market, and a new question for sellers: what will be attractive to 1031 exchange buyers, and how do we capture them?
What strikes us is that the market defines risk almost entirely by lease term and tenant credit. Market fundamentals haven’t changed. Vacancy rates, loan defaults and rents all remain relatively unchanged. This is a risk-management reflex, which is common in uncertain times. But 1031 buyers are propping up perceived-safety pricing disproportionately. It is only a matter of time before that pricing normalizes.
Cap Rates Have Room To Move
The spread between medical office cap rates and the 10-year Treasury yield points the same direction.
According to Revista Med’s late September article “Where are MOB Cap Rates?,” over the past 10 years, medical office building (MOB) cap rates have averaged about 363 basis points above the 10-year Treasury. Today that spread is about 223 basis points. Cap rates typically trail Treasury moves by six to nine months, so we expect continued upward pressure.
Inventory is the other side of the story. There is very little perceived-safety product on the market. This is especially true in smaller metropolitan areas like Austin. We have seen firsthand how highly desired markets with limited perceived-safety inventory can push cap rates far below current interest rates.
Much of the inventory squeeze likely comes from owners holding low fixed-rate debt from 2021 and 2022. That debt is now coming due, so we expect more motivated sellers to bring product to market over the next 12 months.
Running The Numbers Against Treasuries
As rates have climbed, one question keeps coming up: “Why would an investor buy at a 7 percent cap rate instead of a 30-year Treasury bond with a yield of 5.6 percent?” We heard it enough times that we ran the numbers. Even without leverage, a stabilized medical office deal returns about 350 basis points more than the 30-year Treasury. Here are the assumptions we used:
- $5 million purchase price at a 7 percent going-in cap rate
- Seven-year, triple-net lease with 3 percent annual rent increases
- A seven-year hold, resold at a 7 percent cap rate with a 6 percent cost of sale
- For the leveraged case: $2 million in equity, a 60 percent loan-to-value (LTV) ratio, a 6.5 percent interest rate and a 25-year amortization schedule
The unlevered number is the fair comparison, since a Treasury carries no leverage. On that basis, the asset itself pays a meaningful premium over the risk-free rate. Add market leverage, and an investor would need a Treasury yield above 11.5 percent to match the deal. Neither figure includes depreciation or other tax benefits, which widen the gap further.
So what does this tell us? There is a ceiling on how far cap rates will normalize, and it isn’t far off. Further, 1031 buyers are keeping some cap rates disproportionately low, but we don’t see 9 percent cap rates or higher becoming the standard anytime soon. Barring a black swan event or major geopolitical shock, we expect a meaningful shift in perceived-safety pricing and a smaller one in perceived-risk pricing.
Where The Opportunity Lies
The best value today is in perceived-risk deals, not perceived-safety deals. Sellers of properties leased to local and regional medical tenants have already repriced to the mid-7-percent cap range. The fundamentals behind those tenants —occupancy, rent levels, default rates — haven’t weakened. Buyers are being paid for a risk the data doesn’t show.
Perceived-safety deals are the opposite. Credit tenants on long leases are still pricing near or below the cost of debt, supported largely by 1031 demand. As the spread to Treasuries normalizes and maturing debt issued between 2021 and 2022 brings more of that product to market, those buyers have the most room to lose.
Date The Rate, Marry The Deal
Taken together, we see today’s market as a strong buying opportunity. Elevated interest rates let buyers lock in higher going-in yields. Those yields are thin relative to current debt, but they can be the foundation of an excellent long-term investment.
As the old commercial real estate saying goes, “date the rate and marry the deal.” Using the same financing assumptions (60 percent LTV, 6.5 percent interest, 25-year amortization schedule, 3 percent annual rent increases), we find that:
- A 7.5 percent cap rate today produces about a 6.6 percent cash-on-cash return
- Five years later, rent growth alone takes cash-on-cash to about 9.6 percent
- If rates ease and the investor refinances at 5 percent, cash-on-cash climbs to roughly 12.2 percent
Even in today’s challenging environment, medical office remains a strong investment. The near-term economics are tighter, but they set up some of the best long-term opportunities we have seen. Now more than ever, it is important for investors in this space to work with an expert who can review every angle, understand the risks and help you act on your investment objectives.