📘 What is Cap Rate Compression?

Cap rate compression is a phenomenon where capitalization rates (cap rates) decline, often because property prices are increasing faster than the income those properties generate. This trend can signal strong investor demand and a competitive real estate market.

As cap rates compress, the return on investment decreases for new buyers, even if the income generated by the property remains the same. It’s a key indicator used by investors to assess market conditions and potential risk.

📌 When and Why It’s Used

Cap rate compression is most often used to analyze market trends during economic booms or in high-demand areas. It reflects investor sentiment and the availability of capital in the market.

Understanding cap rate compression helps investors make informed decisions about timing their acquisitions and anticipating potential yield shifts over time. It can also influence financing, pricing strategy, and exit planning.

🧮 How It’s Calculated or Applied

While cap rate compression isn’t a formula itself, it is derived from the comparison of cap rates over time. If the Net Operating Income (NOI) remains constant but property prices increase, the cap rate will naturally decrease.

This is calculated using the standard cap rate formula. A lower result over time (given steady or flat NOI) is considered cap rate compression.