Cap Rates

CFA Level III Alternative Investments
#1

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 ?

#2

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.

#3

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?

#4

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.

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#5

Thanks for the explanation

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#6

My pleasure

#7

Hi could you please explain how household debt to GDP and online purchases per capita affect cap rates? Here household debt to GDP means more money available so cap rate will decrease am I correct? What about affect of online purchase per capita?

#8

Unless I’m mistaken the curriculum doesn’t make any mention to effect of online purchase on cap rate. But I assume that online purchase increase liquidity and improves price search which would contribute, if I am not wrong, to a lesser premium asked by investor and hence a lesser cap rate.
Moreover more online purchase means more purchase means more borrowing more debt available and hence lesser premium.

Maybe someone more legit on that subject will correct me if I am wrong.

#9

Thanks for your response. Actually increase in online purchase will to increase in cap rate ? I am unable to understand. I have one more question for you CLO mostly contain corporate loan while CDO contains mortagages? Any idea if CLO is short term in nature?

#10

Can you provide the explanation?

#11

“an increase in per capita purchases from online retailers increases the
competition with brick-and-mortar retailers (especially those that are less profitable), and, thus,
should accompany an increase in retail cap rates” . Let me know if you are able to understand. I am confused?

#12

More competition leads to a decrease in price. If price decreases, the discount rate increases and so the cap rate.

But like I explained the result could be the opposite of you consider the increase in debt which improves liquidity with less premium requirement.

I suppose we need the context with more relevant details.

#13

Just to confirm you are saying due to competition market value of brick and mortar decrease which increases cap rate right? Any idea if CLO loan are short term in nature and CDO are long term? Thanks