Top 7 Factors Most Likely to Impact Non-Institutional Real Estate Cap Rates-A Guest Post from Llenrock Group Jul 28, 2014

This post from Eric Hawthorn is part of our Llenrock Group guest post series and originally appeared on the Llenrock Group blog. 

In a follow-up to last Wednesday’s post, the Top 7 Factors Most Likely to Impact Institutional Real Estate Cap Rates, here is a clever variation on that subject: The Top 7 Factors Most likely to Impact NON-Institutional Real Estate Cap Rates. As was the case last week, this ranking comes from Integra Realty Resources’ Viewpoint 2014 and is based upon the feedback of industry members. Enjoy.

7. National Economic Conditions

Different types of real estate serve different purposes, depending on the investor/capital source, the economic climate, and market. Last week we were talking about cap rates forinstitutional real estate (here’s a definition, if you’re interested), which tends to be large, core properties offering stable returns as part of an institution’s larger real estate portfolio. While it would be a vast over-generalization to say that non-institutional assets are necessarily smaller and more opportunistic, they are subject to investments by “little guys” like you and me (unless “you” happen to be a life insurance company or massive pension fund). For non-institutional investors, local markets would be more of a factor than national economics, since these investors probably aren’t considering how the nation’s economy is impacting a geographically diverse portfolio.

6. Real Estate Risk Premiums

We saw last week that “the difference between going-in capitalization rates and the 10-year US Treasury yield… the ‘yield premium’ was deemed to have the least potential to impact future cap rate movements.” IRR, in its commentary, suggests this fact–which seems to hold true for non-institutional assets as well, in investors’ minds–indicates that “rising Treasury yields don’t necessarily have an immediate and direct impact on real estate cap rates” (IRR).

5. Local Economy

Local economics naturally have a greater influence than national economics, since real estate is largely a localized asset (there are exceptions, of course, like data centers and industrial properties, which may operate at a more regional, national, or international level).

4. Property Income Growth

Since property income (along with property value) is one of the things that determines a cap rate, we can naturally expect that cap rate increase/contraction will correlate, to a significant degree, with the improvement or deterioration of a property’s net operating income.

3. Availability of Financing

Since the availability of financing influences (but doesn’t determine) real estate demand, property values move accordingly. We also have to think about the cost of available financing, which affect the property’s income (see below).

2. Supply/Demand

This affects institutional and non-institutional real estate alike. If a property has too much competition, it simply won’t be able to attract and retain enough tenants to see a suitable stream of income.

1. Interest Rates

Interest rates show up at #3 on last week’s ranking, but prove even more essential to investors in non-institutional assets, who typically have less access to capital and less equity to commit. While affordable debt is a must for nearly all real estate deals, regardless of locale or asset class, it is particularly important to those who–you know–don’t manage a multi-billion dollar private equity real estate fund.

Author: Raymond T. Cirz