Bob Nelson – Cap Rates And Interest Rates

Today we’re discussing cap rates and interest rates. Thanks so much for tuning in to the Real Estate Today Podcast.

I’m Bob Nelson, real estate investment broker with Pacwest Real Estate Investments. Joining me today is René Nelson. René is a very accomplished commercial broker, owner of Pacwest Commercial Real Estate in Eugene.

René Nelson: Thanks Bob. Let’s talk about cap rates and what we’re specifically seeing the change in those as interest rates change. Because we know interest rates are starting to creep up and we’re going to see probably a couple more additional increases this year. How’s that going to affect cap rates for five units or larger in Eugene?

Bob Nelson: Well, let’s say in the I5 corridor in the state of Oregon, so that’s really … The I5 corridor within 15 miles east or west has defined the vast majority of all commercial activity in the state of Oregon. You can look at that as a fairly uniform belt. The cap rate is, again, a relationship between the net income a property’s capable of generating on an annual basis, the rent that came in, all the expenses that are paid. If you left the leftovers, quote unquote, in the pot at the end of the year, that would be it’s net operating income.

As the net operating income, let’s just assume it stays constant. But that the market, let’s assume just briefly that the market continues to increase. There’s relationship then between value, that which is being paid, let’s say investment value, and net operating income. What’s happening, interestingly enough, there’s a huge demand still for income properties, and not very many of them available to be purchased. Which then causes what? Price versus availability of product. Price goes up. Productivity goes down a little bit because you’re having to pay more and more for that same net operating income dollar.

But what happens when the cost of … Which again, so what I’ve just stated should cause the cap rates to go down, continue to decline. But what happens when the cost of capital or the mortgage interest rate increases? The investor has to maintain a spread between the interest rate they pay on a mortgage loan and the cap rate or the productivity of that property as its own free and clear of debt. So if the mortgage interest rate increases by a half of percent, the cap rate would have to increase by a half a percent or the investor’s losing their overall return.

So this is interesting. It’s something that’s happening right now. We’re experts in that particular thing. Give us a call if you have questions. We’ll go from there.

I’m Bob Nelson, real estate investment broker with Pacwest Real Estate investments.

Join Bob Nelson and Marcia Edwards Eugene, Oregon, real estate experts daily at 5:30 on KPNW for the “Real Estate Today ” radio show.