The interest rate hike has been a major topic in the financial world recently, with many experts speculating on its impact on the economy.
One area that has been affected by this development is the real estate market, specifically the cap rate. A cap rate, also known as capitalization rate, is the ratio of the net operating income (N.O.I.) of an income-producing property to its sales price. It is used to determine the potential return on an investment in real estate.
As interest rates rise, the cost of borrowing money increases, which in turn raises the yield required by investors so they can off-set the additional cost of borrowing money. This increase in yield requirement is possible in two ways. One, by increasing the building’s performance (N.O.I) and two, by lowering the sales price by the sellers.
In an inflationary environment if the interest rates are rising sharply (2022), it is common for investment properties to see marginal increase in their N.O.I due to the increase of demand for rental properties but this marginal increase in performance is not near enough to overcome the radical increase of the cost of borrowing money and therefore the property sales prices have to come down to make up for the invertors margins before they can move forward with their purchase.
This decrease in sales prices can also be seen as a positive development for investors, as it provides them with an opportunity to acquire properties at a higher cap rate now and then later take a much more attractive return by refinancing, once the interest rates come down on the cycle.
In conclusion, the recent rise in interest rates has led to an improvement in cap rates in the real estate market, which can be beneficial for investors in long run. This development has resulted in higher returns on investment, providing investors with more opportunities to acquire properties at a lower cost.
We see this effect across the board in all Chicago’s multifamily and commercial markets from the south side to west, north and across all suburbs and believe this is true in most US markets.
It is worth noting that the real estate market is complex and influenced by various factors, such as location, property type, and the overall economic conditions. Therefore, it's important to consider the specific characteristics of a property and the market conditions before making a real estate investment.