Cap Rates, Interest Rates and Valuations
Real estate capitalization rates and interest rates are two important measures that investors use to determine the attractiveness of an investment. In this article, we will discuss the connection between these two metrics and how they can impact your decision-making process.
As you probably know, capitalization rates (or cap rates) are a measure of the expected return on investment for a property. In general, a higher cap rate indicates a higher expected return and vice versa. Interest rates, on the other hand, are the cost of borrowing money to finance an investment.
So what’s the connection between these two measures?
The answer lies in the time value of money. When interest rates are low, it costs less to borrow money to finance an investment. This means that investors can afford to pay more for a property and still earn a good return on their investment. As a result, we tend to see prices increase and cap rates decrease when interest rates are low.
Conversely, when interest rates are high, it becomes more expensive to borrow money and investors are less willing to pay as much for a property. This results in lower prices and higher cap rates.
Of course, other factors can impact prices and cap rates besides interest rates. But all things being equal, the direction of interest rates is one of the most important drivers of changes in real estate values.
If you’re thinking about investing in real estate, it’s important to pay attention to both capitalization rates and interest rates. By understanding the relationship between these two measures, you’ll be in a better position to make informed investment decisions.