I have been wondering and reading about the low cap rates. I think the low cap rates are due to the excess money in the market due to low interest rates. It seems that for the last few years the cap rates have been going down - from an average of 8% to 6%. It is even lower in markets like California where I live. I beleive that now the interest rates will rise slowly. You will see a depression in the real estate market (bad loans, etc). The higher interest rates and depression will probably affect the economy. In this case, the rents may actually go down. So, the property price will go down since NOI will go down. Additionally, since the interest rates are higher the cap rate will need to increase, decreasing the price of the property further. Some people think that the rising interest rates will not affect the cap rates and that there is a paradigm shift. Not at all. Income producing properties will be always be priced based on the income they generate. Sometimes, when the times are good and prices are rising the speculators will buy based on appreciation driving the cap rates down. Some will make profits but many will suffer. Please share your thoughts.
Suppose I buy a property today with a cap rate of 5%, and then sell it 10 years later. I assume that with rising rents over the years my personal cap rate will eventually be higher than 5%. (This is also assuming the tenant covers NNN)
So getting in at a low cap rate isn’t that bad is it?
When I go to sell it 10 years from now I would assume there would be demand from two types of buyers:
An Investor who is interested in a decent cap rate return or wants to flip.
A buyer who values the location for their personal or business use.
Someone correct me if I’m wrong, but as the property’s net income rises, all else remaining the same, the property’s value would increase based on the cap rate. The rising NI wouldn’t change the cap rate. The cap rate expresses the multiple of NI that a buyer would be willing to pay you for the property.
If you want to lower the cap rate (which gives you a higher multiple), you’d need to convince a potential buyer that it is worth the higher multiple. This would be based on property improvements, tenant/lease improvements, postiive demographic changes, etc… Higher demand for the type of property you would be trying to sell would also have the same effect.
For a buyer of any given property, a higher cap rate, which translates to a lower multiple, is always better.