Cap Rate question

CFA Level III Alternative Investments
#1

Probably an extremely simple question, but I still cant fully understand the logic:

Joshua Petersen is a real estate analyst that wants to make appropriate adjustments to a capitalization rate. He predicts that vacancy rates will increase and that the availability of credit will decrease. Based on these views, it is most likely that Petersen:

a) should increase the capitalization rate.
b) may need to either increase or decrease the capitalization rate because the two predictions have offsetting effects.
c) should decrease the capitalization rate.

The correct answer is a) and the rationale is that these 2 factors would reduce the value of the real estate.

But my thinking was that NOI should also be affected by the vacancy increase, so it’s not only the denominator changing here ( cap rate = NOI / Market value)

Where am I wrong?

#2

Fair point. When I looked at the question, I went with a) because both effects contribute to lower value of real estate. Sure, increase in vacancy rate impacts NOI as well, but less availability of credit would still hit value of real estate.

Therefore, the denominator would decrease more than the numerator, resulting in higher cap rate.

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#3

By a higher percentage?

Is that guaranteed?

#4

Thanks for your participation. Not sure if this question is too clear so that nobody else responded, but thanks for the two replies above anyway.

#5

I think the simplest way to look at this question is - it’s purely asking you what you want to do with the cap rate, no NOI mentioned at all…and things that would ultimately result in a slowdown (like higher vacancy rates and less available credit) will result in an increased cap rate.

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#6

You are correct. If all else remains the same. If NOI falls. Mkt value flat (or fall by lower %) than cap rate increases. But this is a prediction of the future and expectations.
You are usiing cap rate to value a property.
Commerical retail tenants have been paying $100,000 a year. There has been 100% occupancy. Cap rate similar property 10%. Value $1m.
Selling agent now tells you a newer developement is about to complete near by, the core tenant is having finanical issues and they expect the vacancy rate to increase going forward.
Does your value of the peoperty increase ot decreease? Future NOI will not match historic but also volatility of NOI will increase, increasing risk and thus increasing the return required.

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