CAP Rate Compression – What Does It Mean?
Capitalization Rates, or Cap Rates, are a key performance measure for any commercial real estate investor. A property’s Cap Rate represents the rate of return that the investor would receive on an all-cash investment in a property if it were occupied by a reliable tenant. Very simple on the surface, they are determined by dividing the net operating income (NOI) by the total value of the property. Generally speaking, the higher the Cap Rate, the better the investment for a given level of risk. “Sometimes the values of properties are bid up by the market even when NOI’s remain unchanged, effectively lowering the Cap Rates. This is what we call Cap Rate compression and it is happening in U.S. markets right now,” said Dr. Philip Seagraves.