Cap Rate Historical Trends

[Matthew Shay]

This is a silly question possibly. I have heard people in forums says regarding cap rates to pay attention to the overall trend. Just because you bought at a 7 cap today you need to follow the historical trends of the cap rate because it is likely to go back. Having said my current goal is primarily stable cash flow and less focussed on the appreciation. My question is for those who are primarily appreciation driven at what point would they be invested in a low cap rate property with a higher cap rate historically. Would you wait 5 years, 10 years to accept/be convinced about the current cap rate? Also, what other factors would you take under consideration to override the higher historical cap rate? Much appreciated!

[Immanuel Sibero]

@Matthew Shay

Always interested in discussion of cap rate because it's often misunderstood and I'm a newbie trying to learn as much as I can. A couple of references to cap rate on this thread sound backwards to me.

For example, your question: those who are primarily appreciation driven at what point would they be invested in a low cap rate property with a higher cap rate historically..

If I was appreciation driven, I likely would be a market timer (i.e. buying when it's low). However, with historically higher cap rate properties I would NOT be buying when the cap rate is low, I would wait till the cap rate comes back to its higher historical levels. Remember with cap rate, you buy high and sell low.

Along the same line as with @Greg Dickerson's post - primary markets and class A properties will always command LOWER (not higher) cap rate when compared to secondary/tertiary markets or B, C class properties. Below is a snippet from cap rate survey showing that class A properties always command lower cap rates (i.e. not higher):

City	State	Property Class	Multifamily
New York	New York	A	2.52
New York	New York	B	5.06
New York	New York	C	6.70
Los Angeles	California	A	2.62
Los Angeles	California	B	5.75
Los Angeles	California	C	7.31
Chicago	Illinois	A	4.31
Chicago	Illinois	B	6.08
Chicago	Illinois	C	9.07
Houston	Texas	A	5.23
Houston	Texas	B	7.26
Houston	Texas	C	8.09

I do agree that cap rate is driven by supply and demand and long term trend of interest rate. Matter of fact, it goes even further, cap rate is driven by the economy, demographics, location, etc. There is also this "chicken or the egg" question with cap rate and valuation. There is a perception that cap rate determines value so we need to study and watch cap rate. The reality is the general state of the economy drives interest rate which drives asset valuation, and in turn asset valuation drives cap rate, NOT the other way around. Historical cap rate is what the economy has done to asset valuation so if you want to know where cap rate is going then figure out what the economy will do to asset valuation.

Cheers... Immanuel