Cap Rate Trends
The commercial real estate industry in the US entered a new frontier in 2022 through market challenges driven by inflation and changing US monetary policy. This market is constantly changing and evolving.
We urge real estate investors and asset managers to be aware of the current trends to make sound decisions for their investment portfolios. Among several other metrics used in real estate to understand whether an investment is a right opportunity, keeping an eye on cap rate trends is essential.
Cap rates have a significant impact on your overall return on investment. Changing market dynamics will affect cap rate trends which could have a significant impact on your real estate investment.
What is a Cap Rate?
The cap rate is short for the capitalization rate. It is basically the estimate of your annual rate of return on investment (ROI) if you paid all cash for a multifamily property. It is expressed as a percentage and generally has an inverse relationship with property value which means the lower the cap rate the higher the purchase price.
It is essentially the metric for calculating risk. Properties with higher cap rates are considered risky than properties with lower cap rates. The cap rate formula is relatively simple in concept,
Cap Rate = Net Operating Income (NOI)/Purchase Price
A simple example, you are purchasing a property for $1,000,000, and the net operating income is $100,000. So, the cap rate is $1,000,000/$100,000 or 10%.
The work that goes into determining net operating income is not simple, it takes into consideration many variables and in some cases is subjective in nature. The net operating income refers to the total annual gross collected income from the property minus its annual operating expenses.
Some of the variables at the property level that will affect net operating income are property age, location, local market supply and demand, and property condition.
What Factors Affect Cap Rate Trends?
Several factors can affect the current cap rate for multifamily investments. Some of the most common factors are:
1: Interest Rates:
In our view, this is the single largest factor that affects cap rates. When interest rates in the market decrease, cap rates also tend to fall but when they rise cap rates rise. This can cause substantial swings in market value.
2: Local Economic Growth:
If the local economy is growing it suggests an increased demand for rental apartments. This will have a positive impact on real estate values and thus lower cap rates are acceptable. If the local economy is shrinking it will have the opposite effect.
3: Inflation:
It has an interesting and somewhat subjective impact on capitalization rates. In theory with inflation, it becomes more expensive to add supply which should in theory protect existing real estate values suppressing cap rates. The opposite thought is with higher inflation usually comes higher interest rates which cause cap rates to rise. Which is actually correct is somewhat speculative.
Understanding Current Cap Rate Trends
Understanding the current cap rate trends is essential. It provides investors guidance on pricing properties today and where they might be in the future. The cost of capital is increasing across the United States, which is expanding multifamily cap rates. The cap rate for multifamily properties continues to rise in all US markets.
How Can Asset Managers Maximize Returns in the Current Multifamily Environment?
Real estate investors can use cap rates to compare potential returns across multiple markets and focus on investing where they think they will have the best short- and long-term return on investment.
Asset managers can connect with the right experienced property management firms in their preferred markets to help maximize net operating income. Summerfield Property Management is an experienced top-notch management firm that can help you achieve your goals.
Cap Rate Trends: Conclusion
Small changes in cap rates have a significant impact on property values. It is very important to pay attention to the factors that impact cap rate trends. It is even more important to dial in and develop expert knowledge for your preferred investing markets.
One of the ways to develop market expertise quickly is to align yourself with the right management firm. Summerfield Property Management has a ton of experience in managing multifamily properties, and we can help provide exceptional services.
Cape Rate Trends: FAQs
Q: Is 2023 a good year for apartment real estate investors?
A: Overall, the residential markets are healthy across most major markets but rising interest rates and their impact on cap rate trends require you to proceed cautiously when considering buying a multifamily property in 2023.
Q: What is a cap rate?
A: Cap rate is short for capitalization rate. It is basically the estimate of your annual rate of return on investment (ROI) if you paid all cash for a multifamily property. It is expressed as a percentage and generally has an inverse relationship with property value which means the lower the cap rates the higher the purchase price.
It is essentially the metric for calculating risk. Properties with higher cap rates are considered risky than properties with lower cap rates. The cap rate formula is relatively simple in concept,
Cap Rate = Net Operating Income (NOI)/Purchase Price
Q: What is the effect of a higher cap rate?
A: The higher the cap rate the lower the property value.
