Real Estate Cap Rate Analysis: Update

This post is the first in our new series of monthly updates on appropriate capitalization rate ranges for commercial real estate. If you’d like more context on the data here, have a look at ‘What is a good cap rate?’. This also covers cap rates for the month of July.

August Cap Rates

As we move into August, the cap rates for several of the risk assets we are assessing have gone down. This table demonstrates these changes:

Table depicting cap rate changes for risk assets between July and August

The return on risk free and low risk investment is reduced slightly. The US Treasury yield is down by 0.09% and the investment grade bond yield is down by 0.14%. Meanwhile, the equity REIT is down by 0.21%, the greatest drop in yields. This decrease in return rate means less yield reward for the same level of risk compared to a month ago.

Despite lower figures this month for bonds and other financial investments, there is no change in advertised commercial property loan and construction loan rates. This stacked column chart shows the same data plotted month to month so you can see the relative changes more clearly.

 

Stacked chart depicting percentage change in cap rate for August 2017

Target cap rate for investors

From my perspective, an appropriate cap rate ceiling remains around around 5%, or a 20x valuation multiple on first year net operating income. However this leaves little space for contingency in the event of interest rates starting to rise. I would continue to target at least 7% in this economic environment. With assets finely priced, it is hard to do much more than this based on my conversations with brokers and realtors. Of course, cap rates in more capital appreciation focused locations such as NYC will be tighter.

The longer term risk assets (public and private equity returns) are reviewed annually. Typically you won’t see changes in these month to month.

If you’re interested in finding free independent research to improve your understanding of market dynamics, Marcus and Millichap provide some excellent material such as this report. You’ll need to register to access it but it’s worth it for the quality of the research!

I expressed a personal opinion on cap rates above, but naturally data is better! Are you looking for independent sources of cap rates? Check out the data explorer by dmi.io.

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