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Compressing Cap Rates Shift Buyers’ Market

In our last blog we talked about the many considerations to make when looking at capitalization rates (cap rates) to determine an investment’s value. If you’ve spent any time since then looking at the various cap rates of current offerings or read any articles about average cap rates around the nation, you may have realized that cap rates vary significantly from one market to another, from one region to another, from one property type to another.

Over the last quarter there has been much discussion on the compression of cap rates in California commercial real estate. As property values continue to rise, cap rates are falling. With property values increasing at a faster rate than rental rates, cap rates will continue to decrease. A property that cost $1 million two years ago and earned $90,000 annually is now valued at $1.25 million and producing $100,000 annually. This is a cap rate shift from 9% to 8% in a short period of time. In another year or two, we could see that cap rate drop even further to somewhere between 6-7%.

Current property owners are excited about the increase in property value as they look forward to selling their properties; however, investors looking to purchase properties in California are weary of the compressing cap rates, seeing the investment value of these properties decreasing. Many investors are counting on property values to continue to increase in California, looking for an opportunity to recognize higher returns at the time of sale rather than focusing on the regular income produced by the properties. Other investors are starting to search elsewhere in the nation to find properties with higher cap rates and potentially higher investment values.

With much speculation on the future of the market, many analysts are recognizing some of the nation’s regional markets, like California, reaching property values that reflect pre-recession values. To some this is great news; the nation has a chance to pick up where it left off. To others, this is a time to be cautious. The last time property values got so high and the cap rates became too low; there was an imbalance, and the markets crashed. Of course, no one can absolutely predict what will happen in the next quarter, the next year, or the next five years, but it can be a good idea to pay attention to such shifts and consider the patterns of history.

The good news is that, while California’s commercial real estate market may experience a slow-down due to the compression of cap rates, there are many other places in the nation that are certainly maintaining higher cap rates and appealing to buyers.

We at 1031 Crowdfunding are optimistic about the future of real estate investing through the Delaware Statutory Trust model. With any Delaware Statutory Trust offering we consider for our platform, we are diligent to study the local markets to recognize regions and property types holding steady cap rates and providing high valued investments to investors.

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