Previously, myNOI covered how cap rates were calculated. Now, we’ll describe the other factors that go into determining current cap rates.
At their simplest, cap rates are just the annual net operating income divided by the cost paid for the property. However, much more influences current cap rates than those two sums! Investors use cap rates to compare similar investment opportunities in the market by associating the risk of each with a number. Because each market is different, the best cap rate analysis looks at a number of different factors:
The location of a commercial property influences current cap rates. Demand drives prices, and the nearer a property is to areas with lots of traffic, the higher the price. Demographics like major industries, employment rates and median household income all affect the risk associated with investing in a property.
If the area is experiencing a boom in the finance sector, then low cap rate’s for office buildings are likely to reflect a safer bet. Contrast this with a shrinking market, where high cap rates will likely show a much riskier investment for office space.
It’s not just the location that influences current cap rates, it’s also the asset type of the property you’re looking for! Multifamily units are usually considered safer investments than retail properties, and so they tend to have lower cap rates. Everyone needs a place to lay their head at night, even during a recession. A retail building, however, is much riskier because of its reliance on a strong economy to remain sustainable. You can expect to see that difference reflected in the current cap rates for the different asset types.
Finally, the interest rates offered by financial institutions impact current cap rates. High interest rates mean it will likely take longer to pay back the loans you took out for the property, leading to higher risk. You may have changed nothing about your property, but if the federal government raises interest rates by 1%, you’ve suddenly got a building worth less, because of the extra money required to pay it all back.
Cap rates are highly variable depending on the market, and oftentimes require you to connect with a certified local broker for an in-depth analysis. However, myNOI’s investment calculator can give you an idea of your property’s cap rate. Use our local cap rates tool to also get a bird’s eye view on your area’s current cap rates.