what affects the cap rate 
there are many potential market factors that can affect the capitalization rate of a property as with other rental properties location plays a major factor in determining the returns of commercial properties with high traffic areas likely to come with a higher capitalization rate it is also important to consider other features of the local market such as competing properties generally properties in a large well developed market will tend to have lower capitalization rates due to competitive pressures from other businesses future trends such as local market growth can also affect the long term capitalization rate for a property finally the amount of capital you invest in a property can also affect the cap rate a renovation that makes a property more attractive could command higher rents increasing the owner s operating income examples of the capitalization rateassume that john has 1 million and he is considering investing in one of the two available investment options one he can invest in government issued treasury bonds that offer a nominal 3 annual interest and are considered the safest investments or two he can purchase a commercial building that has multiple tenants who are expected to pay regular rent in the second case assume that the total rent received per year is 90 000 and the investor needs to pay a total of 20 000 towards various maintenance costs and property taxes it leaves the net income from the property investment at 70 000 assume that during the first year the property value remains steady at the original buy price of 1 million the capitalization rate will be computed as net operating income property value 70 000 1 million 7 this return of 7 generated from the property investment fares better than the standard return of 3 available from the risk free treasury bonds the extra 4 represents the return for the risk taken by the investor by investing in the property market as against investing in the safest treasury bonds which come with zero risk property investment is risky and there can be several scenarios where the return as represented by the capitalization rate measure can vary widely for instance a few of the tenants may move out and the rental income from the property may diminish to 40 000 reducing the 20 000 towards various maintenance costs and property taxes and assuming that property value stays at 1 million the capitalization rate comes to 20 000 1 million 2 this value is less than the return available from risk free bonds in another scenario assume that the rental income stays at the original 90 000 but the maintenance cost and or the property tax increases significantly to say 50 000 the capitalization rate will then be 40 000 1 million 4 pay attention to rates in general cap rates increase when interest rates go up in another case if the current market value of the property itself diminishes to say 800 000 with the rental income and various costs remaining the same the capitalization rate will increase to 70 000 800 000 8 75 in essence varying levels of income that get generated from the property expenses related to the property and the current market valuation of the property can significantly change the capitalization rate the surplus return which is theoretically available to property investors over and above the treasury bond investments can be attributed to the associated risks that lead to the above mentioned scenarios the risk factors include 