Weird cap rate observation...

[Jackson Long]

If your income stays the same, but the market spikes and value goes up- your cap rate goes down right?  Kinda weird.

[Immanuel Sibero]

If you assumed that cap rate is somehow a measure of performance or profitability of a property (i.e. the higher the cap rate the more profitable the property is) then yes, it would seem weird, anomalous, backwards for cap rate to go down when income stays the same and value goes up. You would think cap rate would also go up (i.e. the higher the cap rate, the better the property). There are many posts here on BP that reflect this line of thinking such as:

- "my minimum cap rate is 10%, I wouldn't even look at a property with cap rate below 10%"

- "I'm going to buy this property, do some value add, increase the cap rate, and sell it for a profit"

This is a misconception because cap rate is NOT necessarily a measure of profitability, it is a measure of desirability of the property. The one thing to note is that cap rate measures desirability in an inverse fashion (i.e. the lower the cap rate the more desirable the property is).

We can think of cap rates as simply exchange rates (i.e. as in foreign currencies). Cap rates simply tell you how many dollars worth of Value you would fetch for each dollar of NOI. They are just conversion rates! The don't tell you much else, they certainly don't tell you whether the NOI has been generated by a highly profitable or barely profitable properties.

So, when value goes up while income stays the same, it is likely that the area has become more desirable for one reason or another.... it expected that cap rates go down in this case (i.e. they reflect the higher desirability of the property).

Immanuel