Could anyone explain how cap rate is affected by different factor like changes in interest rates ,vacancy rates, the availability of credit and the availability of debt financing ?
The cap rate is like a discount rate used to value a real estate property or said differently its expected return considering the idiosyncratic risk. This is the net operating income divided by the value of the property even if like the curriculum says some of the operating income is dedicated to maintenance and repairs.
If the vacancy rate is high you will ask for a higher discount rate (ceterus paribus) because the investment risk is higher.
Every variable which increases the investment risk will increase the discount rate and hence the cap rate.
Thanks for the explanation but why would investment risk will be higher? I am unable to understand? Also how does credit spread & Cap rate affect each other?
We don’t want the investment risk be higher. We want to be compensated for higher risk which then increases the cap rate required.
Basically cap rate= risk free rate + credit spread-expected -NOI growth rate.
If debt is more available the risk free rate should be lower decreasing the cap rate.
If credit spread is higher, meaning higher risk of default, you should be compensated for that which increases the cap rate.
Hope this helps.
Thanks for the explanation