Below are examples of changes in NOI and Cap Rates that cause asset values to rise or to go down :
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As NOI increases and Cap Rates remain the same , asset values will increase . ($ 300,000 reflects net operating income and . 06 reflects a 6 % cap rate )
$ 300,000 /. 06 = $ 5,000,000 $ 350,000 /. 06 = $ 5,833,000 $ 400,000 /. 06 = $ 6,666,666 $ 450,000 /. 06 = $ 7,500,000
As NOI remains the same and cap rates rise , asset value will go down : ($ 500,000 reflects net operating income and . 03 reflects a 3 % cap rate )
$ 500,000 /. 03 = $ 16,666,666 $ 500,000 /. 04 = $ 12,500,000 $ 500,000 /. 05 = $ 10,000,000 $ 500,000 /. 06 = $ 8,333,333
Correlation Between Cap Rates and US Treasuries :
The US Ten Year Treasury Note ( UST ) is deemed to be the riskfree investment against which returns on other types of investments can be measured . USTs yields have been on a broad decline for many years but may soon rise . As interest rates increase those investors who bought USTs at a lower rate will find that their bonds will go down in value . Bonds purchased at the new higher rates will be in high demand .
When the government intrudes in the market , the results are artificial . This has caused capitalization rates to go down , reflecting higher values .
As interest rates rise , Cap Rates will go up , and consequently , there will be a reduction in asset values over time . With so many uncertainties in the market and growth projections constantly being revised , the spread between UST and Cap Rates has not remained constant .
When the government intrudes in the market , the results are artificial . This has caused capitalization rates to go down , reflecting higher values . Nearzero interest rates have also caused a dramatic inflationary spike in all goods and services .
Summary :
Property appreciation from excess demand has been one of the most significant reasons for investing in real estate Appreciation is not part of the Cap Rate calculation . For investors , lower interest rates , tax benefits of owning commercial real estate may , in and of themselves , be the driving force to make
such an investment . If the property is to be leveraged , there may be writeoffs for loan fees , interest expenses , operating expenses , depreciation , and capital expenses .
Interest rates have been forced down to extremely low rates , below inflation , by government mandate ! Refinancing at lower rates has resulted in lower debt service payments . Cash flows of incomeproducing properties have gone up , reflecting a higher net operating income . The government intentionally creates market distortions that benefit the insiders at the top of the economic spectrum . The results are artificial . This has caused capitalization rates to go down , reflecting higher values . Nearzero interest rates have also caused a dramatic inflationary spike in all goods and services . All asset classes have now been “ spiked with 200proof illusions ” that make everything seem fantastic on the surface . But hangovers the day after the party ends are no fun .
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