What is cap rate expansion?

Cap rate expansion means market cap rates are rising. Because price equals net operating income divided by the cap rate, expansion pushes values down even when rent never changes. The site's default property earns $28,892 of NOI at a $500,000 price, a 5.78% cap rate. Let cap rates expand to 6.28% and that same income is worth about $460,000.

That is a loss of about $40,000 with no change in rent or expenses. A full point of expansion, to 6.78%, drops the same income to roughly $426,000. The lower the starting cap rate, the more each point of expansion takes off the value.

Cap rates expand when buyers want more yield. Higher borrowing costs are the usual cause, covered in the interest rate guide. Local ones count too: new supply, softer rents, a jump in insurance, or a block that reads riskier. Compression is the same move in reverse.