The mystical cap rate…
I have written here about the basics of the somewhat mystical ideal of the capitalization rate. I have noted in my article “Cap Rate For Dummies” that the cap rate is “a simple tool to measure the annual rate of return on your property investment. Different geographical areas will have different CAP rates. In general, the more in demand an area, the greater the CAP rate.” For a refresher on these basics, including a cap rate definition and a simplified explanation of what is cap rate, you can check out this article here: http://investinginproperties.org/rental-investments/cap-rate-dummies/.
The current trend
The trend for cap rate real estate over this current year has been somewhat downward however. What I mean is that you should expect a lower cap rate on your investment properties since most investors, including large hedge funds, for example, are buying properties and expecting less returns than in prior years. That is to say, their cash on cash return has been trending slightly downward. (Remember to use our cap rate calculator in the tools section here, or any other online cap rate calculator, to help you crunch your numbers on any given potential property acquisition.)
Predictions holding strong
As noted in an article from Urbanland.uli.org published earlier this year predicting this trend (“Six Trends in Commercial Real Estate to Watch for in 2015,” by Peter Burley and David Lynn, January 5, 2015), the authors guessed correctly that multifamily houses would retain their high popularity with investors. They said that “multifamily transaction volume has reached pre-recession levels, outstripping office transactions for the first time in ten years, as real estate investment trusts (REITs) and pension funds have fed a fierce appetite for the multifamily sector.”
They went on to predict that “the pace is unlikely to slow anytime soon. Apartment demand has been—and is expected to be—robust, supercharged by the shock waves of the recession and by strong demographic trends that are only beginning to manifest. But most interesting is their conclusion about the current state of cap rates. They went on to say that “as values moved ever higher, cap rates fell back toward 6 percent, close to where they stood in 2005 and 2006. Most deals have been concentrated in larger urban markets, such as New York, Washington, Los Angeles, and Chicago, with considerable focus on the echo boomers, who are partial to the amenities of an urban lifestyle, and their parents, who are realigning their housing needs toward walkable surroundings and mass transit.”
The interest rate effect
In their summation, they concluded that property investment would continue to remain robust, even with slightly declining cap rates. This is namely because positive cash flows continue to be impressive with continued high demand from tenants, both in the residential as well as the commercial sectors. Here’s what they predicted about cap rates at the beginning of this year…They concluded that “investors are moving into an array of asset choices in a widening number of markets as they seek ever more attractive yields. Interest rates do not appear ready to rise substantially in the near to medium term (especially in light of the Fed’s ongoing accommodative stance and massive deflationary factors gathering momentum), and cap rates—even in many secondary markets—will continue to compress, creating negative spreads in some larger gateway markets for the first time in many years—a worrisome sign.”
Fundamentals continued to improve
However, for all their fear-mongering, the markets have held up this year despite the cap rate downturn. They ultimately predicted that “while new construction has begun to pick up in a few areas, new product does not appear likely to offset positive absorption trends. The outlook for 2015 is that commercial real estate fundamentals will continue to improve—but will its popularity, as evidenced by ever-increasing investment flows, create the conditions for another pricing bubble?” The answer to date? No. I can foresee that next year pricing bubbles may occur in several major U.S. cities, but not until the Fed raises interest rates. Of course, the Fed has hinted recently that they may do so, possibly as soon as December. Property investors will by and large be taking a wait-and-see, cautious approach and attitude toward their property acquisition strategies for 2016.
In addition, make sure you always keep an eye on the capital appreciation rate in any given area you’re searching in moving forward. As I’ve noted in a prior article here, “it’s the holding and growth investment property tips of the marketplace of houses surrounding your building that will add value to your property in the long run. Be very mindful of this fact.” And don’t forget that your year-to-year cash flow is obviously important to paying the bills and allowing yourself a profit on a regular basis. But it’s when you are ready to sell the building that most of your profit should be made.
photos courtesy of bronxbohemian.wordpress.com, bronxbohemian.wordpress.com, bronxbohemian.wordpress.com, trexglobal.com, anchorloans.com, foreclosuredatabank.com