The commercial real estate market has shown a steady downfall of capitalization rates, or cap rates, over the past numerous years. After the release of The Boulder Group’s Net Lease Market Report, the net lease cap rate trends may slowly be starting to resuscitate. Follow along as I discuss cap rates, contributing factors to their steady decline, The Boulder Group’s Market Report and my thoughts on the vitality of the net lease cap rates.
What are Cap Rates?
The cap rate of a commercial real estate property refers to the capitalization rate. The cap rate in commercial real estate is defined as the ratio of Net Operating Income (NOI) to property asset value. Net Operating Income is a way to measure how much income a commercial real estate property generates. To calculate NOI, investors, property owners and other CRE professionals subtract operating costs from the overall revenue of a property.
Over the past several years we have seen continuous cap rate compression across virtually all sectors of commercial real estate. There are numerous factors that have contributed to this steady drop, including all-time low interest rates and global economic volatility. These aspects drive both domestic and foreign investors toward net-leased real estate, particularly in the United States. Net-leased real estate requires the tenant to pay some or all of the fees, maintenance costs and taxes in addition to rent on a commercial property. Single, double and triple net leases are among the main leasing options. These facts depict net-leased real estate investments as relatively steady and lower risk. Developers have not been able to build enough product to service this increased demand, which has driven cap rates to all-time lows.
The Boulder Group’s Net Lease Market Report
Promisingly, the Boulder Group released valuable information in their Net Lease Market Report for the 2nd Quarter of 2016. The findings might show that we are finally at the tipping point of where investors are beginning to push back. According to the report, cap rates for retail properties remained flat at their historic lows during the quarter, but office and industrial cap rates began to slowly but surely work back up off of their historic lows. The market report mentions that the industrial and office cap rates have increased from 7.25% and 7.26%. According to the report, all of the major facets of CRE have increased cap rates or have remained the same. This shows a possible steady and promising future environment for capitalization rates.
What I find most interesting in this report is the asking vs. closing cap rate gap. The spread between asking cap rates and closing cap rates is widening. For several years, sellers have been able to continue to push the limit on their asking cap rates because the demand continued to be there. It seems now that investors might be beginning to say “enough is enough”. Investors seem to be pushing back against sellers who continue to try to sell at historic low cap rates. Only time will tell, but here is my prediction: barring any major global economic shockwaves that send even more foreign investors to American commercial real estate, we will most likely see cap rates begin to flatten out and slowly inch back up. Now that I’ve shared my thoughts, what do you think of the current cap rate market? Let me know in the comments section below!
About Chris Palmer – Chris has been working with commercial real estate in Pensacola, Florida since 2010. He primary specializes in working with commercial real estate clients on development and investment related properties. Click here to read his full bio, or if you would like to contact him, you can call him at 850-610-8339 or email him at [email protected]