What is cap rate compression in real estate?

What is Cap Rate Compression?

Cap rate compression in real estate refers to the phenomenon where capitalization rates (cap rates) decrease over time. The cap rate is a key metric used to estimate the potential return on an investment property, calculated by dividing the property's net operating income (NOI) by its current market value. When cap rates compress, it implies that property values are increasing at a faster rate than net operating incomes, often due to high demand and competitive investment markets. This compression can lead to lower yields for investors, as the price of acquiring real estate assets rises relative to the income those assets generate. Essentially, cap rate compression indicates a market where buyers are willing to accept lower returns on investment for the perceived safety, stability, or growth potential of real estate assets.

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