Question

What is likely to happen to the average CAP rate in the market under each of the following conditions. Briefly explain.

a. Rising interest rate environment.

b. Growing perception that real estate is becoming riskier than previously viewed.

c. Expectations that future inflation will increase

Answer 1

Capitalisation rate is the overall rate of return which has been expected to be earned by the investors on the real estate property.

A. when there will be rising interest rate environment,it will mean that the overall capitalisation rate is going to increase in order to increase the expectation of the investor to increase his rate of return which is expected to be earned out of the real estate investment because higher interest rate will mean that there will be a situation of inflation in the economy which will lead to increase in the capitalisation rate

B. When there is a growing perception that real estate is becoming riskier than previously viewed, then it will mean thatthere will be a lower expectation of the investor from the real estate and it will mean that there would be a lack of capitalisation rate because there would be lower number of investors willing to invest into the real estate and it will decrease the capitalisation rate as it is reflecting the decrease in expectation of rate of return and by the investor.

C. When there is Expectations that inflation will increase, it will mean that there is an expectation of rising capitalisation rate because increasing inflation is a reflection of increase in demand and it will mean that there will be an increase in the capitalisation rate.