Encyclopedia
Capitalisation rate (cap rate) compression
When cap rates fall, so the same income supports a higher price. The opposite, expansion, means lower prices for the same income.
For example: An owner thinking about selling watches whether buyers are paying lower or higher cap rates than a year ago. (Illustration only, not a real deal.)
This is a general industry term with no single official definition. Your lease or contract wording controls.
Example only, not a real client. Say you bought a building years ago when cap rates in your area were higher. Since then, investor demand has pushed them lower. Even with the same income, your building is now worth more, because buyers accept a lower yield.
What I’d tell a friend
Value can rise from falling cap rates alone, but that can reverse. Do not rely on it as your only plan.
Why it matters to you
When cap rates fall, values rise even if income doesn't. Owners who bought at higher cap rates benefit, but buyers who assume it will keep happening can overpay.
How to use it in your deal
Buyers should understand whether a deal only works if cap rates keep compressing; if rates rise instead, values can fall. Look at the reasons for current cap rates: interest rates, demand for the property type, rent growth expectations and investor appetite. Owners who bought during compression may face lower values if rates expand, which matters at refinancing or sale.
Sellers benefit from compression, so timing matters. Lenders size loans on income and value, so expansion can reduce loan amounts. Don't rely on cap rate changes to make a return; focus on income you can control. Track recent sales and published market reports from appraisers and brokerages, while remembering they're estimates.
Interest rates from the Bank of Canada and bond yields often influence cap rates, but the link isn't exact. Investors should test different exit cap rates when modelling. A small change in the exit cap rate can move the result a lot, so try a few.
Mistakes I see
Assuming compression continues. Ignoring interest rates. Not stress-testing exit cap rates.
In BC and Vancouver
The Bank of Canada publishes rates and bond yields that affect pricing.
Official sources: Bank of Canada: key interest rates
What it means
Cap rate compression is when cap rates fall, meaning buyers pay more for each dollar of income.
It often happens when interest rates fall or demand for a property type rises.
Watch for
Cap rates can also rise, lowering values, especially when borrowing costs go up.
Base your plans on income you can control, such as leasing and management, and test your returns with a higher cap rate when you sell.
Questions to ask before you sign
- Why are cap rates changing?
- What exit cap rate am I assuming?
- What if rates rise?
- Does the deal work without compression?
Keep reading
Related terms: Cap rate, Cap rate spread, Yield (5-yr GoC)
Working through this right now? Questions are free. Book a 15-minute call or call or text 604 256 2002, and I’ll give you a straight answer.
Back to the A–Z index · common questions · tactics to watch for · the shorter glossary
General information for British Columbia only. It isn’t legal, tax, accounting or financial advice, laws and rates change, and reading it doesn’t make you my client. Any numbers or scenarios are hypothetical. Check the linked official source and talk to a lawyer, accountant or other qualified professional before you act or sign anything. See the terms and disclaimer.