Is There Any Correlation between Capitalization Rates and Years?
Chicago, Illinois, October 22, 2008 — The start of the mortgage meltdown over a year ago continues wrecking havoc on the real estate capital markets. In particular, accurate property valuation is nearly impossible as buyers and sellers are sidelined due to limited debt availability.
Few properties are trading hands. Most investors believe values are trending downward in response to economic malaise, oversupply and lack of affordable debt. As such, experts are using higher cap rates for valuating assets for most types of commercial and income properties. Lenders, in particular, are “creating” values by underwriting capitalization rates which may, or may not, reflect current market prices. These cap rates are typically higher than many sellers are buyers expect, resulting in lower loan proceeds based on loan-to-value restrictions. Yet, owners often refuse to sell or acknowledge asset values based on lenders’ higher cap rates, choosing to do nothing, instead.
In this stalemate, who’s right and where are cap rates heading?
An amusing theory discussed by some experts as a humorous factoid suggests that current capitalization rates are directly correlated to the recent year numerical identity as indexed to the current real estate capital boom/bust cycle. Today’s market cycle peaked in 2007, with 2005 and 2006 ranking as the best years for very attractive valuations; in other words, low capitalization rates.
As for 2008, an 8% capitalization rate is the “strike price” for sellers motivated to liquidate properties. While the markets are illiquid and few transactions leave any proof of value, an 8% capitalization rate reflects a weighted-average premium tied to the cost of capital for most types of income properties. Applying the same logic in a downward market, 2009 should yield a 9% rate and a 10% cap rate would prevail in 2010.
Linking cap rates to year numerology is certainly an unrealistic discussion for measuring values in the currently volatile market. Yet as investors search for answers in such uncertain times, numerology adds more theories to an already confusing time.