Definition
Cap rate compression occurs when property values rise faster than income, pushing cap rates lower. This typically happens when interest rates fall, capital floods into real estate, or demand exceeds supply. Compressed cap rates mean investors accept lower income yields, often betting on future rent growth. Cap rate expansion (rising rates) reverses this, reducing property values.
lightbulb Example
A market's cap rates compress from 7% to 5% over 3 years. A property with $100K NOI: at 7% cap, value = $1.43M; at 5% cap, value = $2.0M. The $570K value increase came entirely from cap rate compression, not income growth.
verified_user Key Points
- Falling cap rates = rising property values
- Driven by low rates, excess capital, strong demand
- Compressed caps mean lower yields for investors
- Cap rate expansion reverses gains rapidly