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)
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.
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.
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.
Hi, I have a quick question, but I am not sure if it is correct. Assume that a project that in three years, the value of the property will be higher than it is currently, but your NOI will be at about the same level. The cap rate will be lower/higher/remain same in three years.
It means the cap rate you are using in 3 years is lower that now.
NOI = $5,000 cap rate 10% Value = 5000/0.1 = 50,000
3 years time
Value property $100,000
Implied cap rate : 100,000 = 5,000 / cap rate
cap rate = 5%
cap rate has 2 factors
discount rate and growth (r - g)
Cap rates can fall/valuations rise if disocunt rate rate drops (risk free rates and/or risk factors decline) and/or expectations about future NOI increase.
The model is really just like a perpetuity growth formula from equity
If vacancy rates increase, it typically means the NOI will decrease because fewer tenants are paying rent. Lower NOI would usually lead to a higher cap rate, assuming the market value doesn’t change proportionally.
Think of it this way… . .
As you noted Cap Rate = NOI/MV
a) NOI captures the one year’s lower income due to higher vacancy
b) the MV captures a lifetime of higher vacancy (projected by the analyst in this example) and a higher cost to finance.
B is going to outweigh A by a long shot, even without the credit aspect.