Cap Rates Are Not Static

The cap rate at which a property trades changes over time. Sometimes it compresses (drops), meaning prices rise relative to NOI. Sometimes it expands (rises), meaning prices fall relative to NOI. The driver is rarely the property itself. It is the broader environment.

Understanding why cap rates move tells you when to acquire, when to refinance, and what to expect at exit.

Driver 1: Treasury Yields

Real estate competes with treasury bonds for capital. When 10-year treasury yields rise, investors demand higher cap rates on real estate to maintain the same spread. When treasury yields fall, cap rates can compress.

The historical spread between multifamily cap rates and the 10-year treasury runs 200 to 400 basis points. A 4 percent treasury and a 7 percent cap rate is a normal 300 basis point spread. If the treasury rises to 5 percent and the spread holds, multifamily cap rates expand to 8 percent.

What this means in practice: the rate environment at your acquisition will be different at your refi exit 3 to 7 years later. Always underwrite to a higher cap rate at exit than at acquisition. If you buy at a 7 cap, model exit at 7.5 to 8.

Driver 2: Capital Availability

Periods of abundant capital (low rates, plentiful debt, eager equity) compress cap rates. Periods of scarce capital (high rates, restricted debt, cautious equity) expand cap rates.

Between 2020 and 2022, multifamily cap rates compressed dramatically as capital flooded into the asset class. Between 2022 and 2024, that compression reversed as rates rose and lenders pulled back. The same buildings that traded at 4.5 caps in 2021 traded at 6.5 to 7 caps in 2024.

If you bought at a 4.5 cap and your refi exit happens at a 6.5 cap, your appreciation from rent growth alone is offset by cap rate expansion. The math:

  • Acquisition: $90,000 NOI at 4.5 cap equals $2,000,000 value
  • 4 years later: $108,000 NOI (20 percent growth) at 6.5 cap equals $1,661,538 value
  • You forced $18,000 of NOI but lost $338,000 in value

This is why entry cap rate matters. Buying at a tight cap leaves you exposed to expansion.

Driver 3: Asset Class Performance

Capital flows toward asset classes that are performing well and away from those that are not. Industrial properties had a multi-year tightening of cap rates as e-commerce demand grew. Office properties have had cap rates expand as remote work changed demand.

Within multifamily, garden-style 2-3 story walk-ups in tertiary markets carry higher cap rates than mid-rise institutional product in primary markets, often by 200 to 300 basis points. This spread reflects perceived risk and liquidity differences.

Driver 4: Submarket Dynamics

We covered this in detail elsewhere - submarket cap rates often diverge from metro averages by hundreds of basis points based on local risk, lender appetite, and growth expectations. Submarket-level capital flows can shift cap rates faster than metro averages.

Driver 5: Specific Property Risk

Two identical buildings with identical NOI trade at different cap rates if:

  • One has a single-tenant lease, the other has 50 small leases
  • One is fully stabilized, the other is in lease-up
  • One needs major capital, the other was just renovated
  • One has long lease terms, the other is mostly month-to-month

Investors price these risks into the cap rate they will pay.

How Compression And Expansion Affect Your Strategy

At acquisition: Anchor on the historical cap rate range for the submarket, not just the latest comp. A 6 to 8 cap submarket may show 5.5 cap deals in a hot moment, but the median over 5 years is what matters. Buying at the bottom of the cap rate range is buying at the top of the market.

At refinance: Do not assume cap rate compression. Model your exit cap rate 50 to 100 basis points wider than your acquisition cap rate. If the exit cap actually comes in tighter, that is upside.

At sale: Trust the market. The cap rate at exit will be whatever capital availability and risk perception support that day. You cannot will a cap rate to compress.

Reading The Macro Signals

You do not need to be a macro economist, but track:

  • 10-year treasury yield and its trend
  • Federal Reserve rate guidance
  • CMBS and bank debt market conditions
  • Major institutional buyer activity in your asset class

These move slowly enough that quarterly review is sufficient. The shift from compression to expansion in 2022-2023 was visible in real time if you were paying attention.

When Compression Looks Likely

Cap rate compression typically requires:

  • Falling or low interest rates
  • Strong NOI growth (rental demand outpacing supply)
  • Heavy capital inflows to the asset class
  • Lender competition pushing rates and LTVs

When you see those conditions, that is the time to acquire and lock in long-term debt. The properties you buy at higher cap rates will benefit from the compression that follows.

When Expansion Looks Likely

Cap rate expansion typically requires:

  • Rising interest rates
  • Slowing NOI growth or oversupply
  • Capital withdrawal from the asset class
  • Lender retrenchment

When you see those conditions, your acquisition discipline matters most. Do not chase deals at compressed cap rates if expansion is coming. Underwrite conservatively. Hold cash for the dislocation.

The Steady-State View

For most operators, the practical takeaway is to underwrite assuming exit cap rates will be in the historical median for the submarket. Not the recent low. Not the recent high. The 5-year median. That gives you a defensible exit assumption that holds up regardless of what cycle you happen to be in.