In the previous blog, we studied Cap Rate in detail so, in continuation to that, today I’m going to discuss factors that can affect the cap rate for multifamily. There are several factors so let’s understand each one of them to get thorough knowledge that will be beneficial at the time of investing in multifamily properties.

Down below, I’ve summarized each factor for you.

Type of Property 

Cap rates usually vary because of property type, different types of multifamily properties can have different cap rates.

Cap Rates for retail, hospitality, and industrial differ from market to market. Typically multifamily has low cap rates among all property types. Thus, the risk associated with multifamily is also low.

Property Age 

Older properties often need maintenance and repair, therefore they tend to have higher cap rates as compared to new properties. The other reasons for high cap rates are high operational expenses and the deteriorating physical condition (deferred maintenance) of the building which requires capital expenditures with modern amenities to upgrade the property.

Location of the property 

The cap rate is affected by the location of the property. Areas with higher market value tend to have lower cap rates. This is because the risk associated with these properties are low. Historically, urban properties trade at lower cap rates as compared to suburban or rural multifamily buildings.

Condition of the property 

Properties with better physical conditions and in-demand amenities have lower cap rates than properties that need major capital expenditures to upgrade them to a better condition. Class A-type properties have lower cap rates than Class B or C-type apartment buildings.

Local Competition 

Investors must recognize the influence of local competition. It can be existing competition or potential for new competition based on low land values. The investors must be prepared for any new competition and make value-add improvements to their assets.

Current Market Conditions

Market trends and economic conditions play a major role along with all the above-stated factors. Currently, the market is affected by high inflation and high-interest rates due to which cap rates are also increased. Interest rates and cap rates are correlated. Thus, as interest rates increase so do cap rates.

Assessing different Cap Rates

There are several different cap rates investors use to assess multifamily investments, they are as follows:

1. Going-in cap rate – It is the entry point or initial cap rate which is based on historical T12s (or P&L).
2. One-year out cap rate – It is based on projected Net Operating Income (NOI).
3. Exit cap rate – It is important when investing in a sponsor’s business plan, based on their expectations about a refinance or sale. ‍

These cap rates can vary according to the current economic dynamics so, investors should be aware of these along with market trends to know which will be beneficial for their investment.

The Bottom Line 

Cap rates are one of the most popularly used investment metrics. To maximize its value, look for any room to improve it over time like market dynamics or economic conditions.

However, a high cap rate is an indication of relatively high income but there are other factors to be considered like risk, etc. This will help you make better investment decisions considering the current status of the economy.

Cap Rates are not stable; they vary according to several factors that I’ve discussed above in this blog. Thus, it is significant that you should know all these factors to understand better which one is influencing the cap rates in your investment.