In general, real estate usually is considered to have risk that is somewhere between that of stocks and bonds.
The leases on real estate are similar to bonds, while market rents that will be received when leases renew and the expected sale price of the property in the future have a risk more like stocks. This is somewhat of an oversimplification as individual bonds can be riskier than real estate, just as some stocks might be considered less risky.
The main point is that investors will evaluate real estate investments within the context of other investment alternatives.
In real estate, Just as users are interested in acquiring space in the space market, investors are deciding whether to acquire buildings that can be leased to these users. Investors will consider what return they can expect from their investment in real estate, which depends to a large extent on current market rents and how investors think those rents will change over time due to fluctuations in the supply and demand for space in the space market.
Depending on how the expected return on the property compares to other investment alternatives with similar risk, or depending on how the expected risk-weighted return on the property compares to other investment alternatives, real estate as an investment will be in demand—that is, a demand for capital to flow into the real estate asset class.
This demand must be met by the existing supply of buildings available for investment, which might include owner occupied space since those users could decide to sell their buildings and lease them back. The interaction between the demand for real estate as an investment and the existing supply of space results in the value of space in what is referred to as the capital market.
The value for space often is expressed relative to the NOI that would be expected during the first year of property ownership. The ratio of NOI to the price investors are willing to pay for the property is referred to as the capitalization rate, or cap rate. The cap rate is what investors are willing to pay for a dollar of NOI.
The cap rate provides an important gauge of what investors are willing to pay.
We could say that the cap rate implicitly reflects investors’ expectations of the NOI and/or value growth, as well as leverage and tax benefits. For example, investors will be more willing to purchase a property at a lower cap rate (higher purchase price compared to the current NOI) if they expect the NOI and/or value to increase over time.
The leases on real estate are similar to bonds, while market rents that will be received when leases renew and the expected sale price of the property in the future have a risk more like stocks. This is somewhat of an oversimplification as individual bonds can be riskier than real estate, just as some stocks might be considered less risky.
The main point is that investors will evaluate real estate investments within the context of other investment alternatives.
In real estate, Just as users are interested in acquiring space in the space market, investors are deciding whether to acquire buildings that can be leased to these users. Investors will consider what return they can expect from their investment in real estate, which depends to a large extent on current market rents and how investors think those rents will change over time due to fluctuations in the supply and demand for space in the space market.
Depending on how the expected return on the property compares to other investment alternatives with similar risk, or depending on how the expected risk-weighted return on the property compares to other investment alternatives, real estate as an investment will be in demand—that is, a demand for capital to flow into the real estate asset class.
This demand must be met by the existing supply of buildings available for investment, which might include owner occupied space since those users could decide to sell their buildings and lease them back. The interaction between the demand for real estate as an investment and the existing supply of space results in the value of space in what is referred to as the capital market.
The value for space often is expressed relative to the NOI that would be expected during the first year of property ownership. The ratio of NOI to the price investors are willing to pay for the property is referred to as the capitalization rate, or cap rate. The cap rate is what investors are willing to pay for a dollar of NOI.
The cap rate provides an important gauge of what investors are willing to pay.
We could say that the cap rate implicitly reflects investors’ expectations of the NOI and/or value growth, as well as leverage and tax benefits. For example, investors will be more willing to purchase a property at a lower cap rate (higher purchase price compared to the current NOI) if they expect the NOI and/or value to increase over time.
COMMERCIAL REAL ESTATE
TRANSPARENCY | CAPITAL PRESERVATION | INCOME STREAM | TAX SHELTER | HEDGE AGAINST INFLATION
VALUE APPRECIATION | PRIDE OF OWNERSHIP
TRANSPARENCY | CAPITAL PRESERVATION | INCOME STREAM | TAX SHELTER | HEDGE AGAINST INFLATION
VALUE APPRECIATION | PRIDE OF OWNERSHIP
