What are the main drivers of Cap Rates?
I was thinking:

When the economy is doing well, investors are taking more risk in the markets, interest rates rise, you know the story.

If this is the case, wouldn't - theoretically - Cap rats increase as well, to keep up with bond / fixed rate yields? How come, during this recovery, interest rates have been compressing?
[{"id": "deh5tqx", "text": "You're right- the risk free rate is one component of market Cap rates and, all else being equal, high rates would mean lower real estate prices. However, because all interest bearing assets are influenced by the risk free rate, it becomes irrelevant in capital allocation decisions. The important thing to consider is the market risk premium for the asset class.", "replies": [{"id": "deh625q", "text": "&gt; However, because all interest bearing assets are influenced by the risk free rate, it becomes irrelevant in capital allocation decisions.\n\nCould you elaborate on this?\n", "replies": [{"id": "deh9nwx", "text": "Sure- the Capital Asset Pricing Model dictates that the return on any asset is given by the following formula: R = rf + rm + alpha where rf = risk free rate (T-Bills), rm = market risk premium, and alpha = additional return to compensate for asset specific risk. \n\nThere is a market risk premium for every asset class, and every specific asset has its own alpha, but the risk free rate is constant across all assets and asset classes. This means that if I am an investor looking to allocate capital among stock, bonds, real estate, etc, the risk free rate can effectively be ignored as it stays the same, regardless of what asset class I choose. The more relevant factor is the market risk premium for the asset class. \n\nFor example, If the risk premium for stocks becomes too low (i.e. I do not believe I am getting an appropriate return when considering the risks I am taking by purchasing common stock) I will reallocate my capital to asset classes that I believe are giving me such returns. ", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "deheu2b", "text": "Yellen", "replies": [{"id": "dehlbsk", "text": "This. Investment grade real estate is competing for capital against the bond market so....", "replies": [], "depth": 2}], "depth": 1}, {"id": "dehmtsi", "text": "so what was the final conclusion? ", "replies": [{"id": "dk4ntsj", "text": "Theory and practice arent always congruent.As Im thinking about it....these are just thoughts.... Someone explained the CAPM model, well,  you could think of cap rates decreasing, despite higher interest rates, as buyers perceiving the market risk to be decreasing. I think the alpha would stay the same, buyers will still want alpha over treasuries...otherwise they would just buy treasuries.", "replies": [], "depth": 2}], "depth": 1}, {"id": "dehpc4h", "text": "Another way to look at the current rate compression is by the supply and demand of investors within a given asset class and market. There are currently more buyers than sellers for quality assets in key markets as times have been good and investors currently have easier access to capital (both equity and debt). The greater demand by buyers is resulting in competitive bidding to win desirable assets further compressing the resulting cap rates.", "replies": [{"id": "dek7mw3", "text": "this^", "replies": [], "depth": 2}, {"id": "dk4nese", "text": "I like this. This reminds me of something I read that compares cap rates to P/E ratios for stocks. As demand increases for a stock, the price someone is willing to pay, relative to an expected return, increases. Similarly, if you were to take the inverse of a \"high\" P/E ratio, you basically have an equation for a low cap rate.", "replies": [], "depth": 2}], "depth": 1}, {"id": "dl85uce", "text": "I've read through all of these comments and none of them are insightful. \n\nI specialize in retail and multi-family development. Understanding Cap rates is a big driver in understanding how to unlock value.\n\nFirst - interest rates are a major driver of cap rates. Because you have no control of this and nobody can really predict which way they'll move, stop putting mental effort into assessing the impact of interest rate fluctuations on your cap rates. You should focus on major drivers within your control:\n\nQuality - the quality of your asset will directly impact your cap rate. These can be factors like:\n     - Location: higher quality locations will have lower cap rates. Better locations (e.g. Hollywood) will usually lead to higher growth in your rents, and consequently, will have lower cap rates.\n     - Asset quality: the construction build / aesthetics / quality tenancy will impact your future NOI (e.g. how sought after will your site be? Is it brand new? Beautiful? Good ingress/egress)\n     - NOI Growth: If you have higher growth in NOI, you'll have lower cap rates. A tenant with 5% rent increases will lead to your property having a lower cap rate than a tenant with 1% rent increases - all else being equal.\n\nIf you understand these basic factors, you can understand how to pull these value levers to increase the value of your property. For instance, you can structure a lease with a quality tenant with 3-4% annual increases and you'll add a ton of value onto your property value.", "replies": [{"id": "dl8q197", "text": "This is helpful, but I am still trying to connect the dots:\n\n&gt; f you have higher growth in NOI, you'll have lower cap rates. A tenant with 5% rent increases will lead to your property having a lower cap rate than a tenant with 1% rent increases - all else being equal.\n\n&gt; For instance, you can structure a lease with a quality tenant with 3-4% annual increases and you'll add a ton of value onto your property value.\n\n**Why would NOI *GROWTH* lead to a lower cap rate?** Correct me if I am wrong: but is it because buyers are typically targeting a certain return (call it: x% IRR)? And if a property has certain revenue growth (in this case, annual rent increases), buyers can tolerate a higher price and still hit their x% IRR, which would thus lead to a lower cap rate on the transaction?", "replies": [], "depth": 2}], "depth": 1}]