Set out the economic drivers of investment in commercial property
The idea
Commercial property sits between bonds and equities. Its income comes from leases: long leases to strong tenants make the rent stream bond-like and sensitive to interest rates, while short leases, vacancy and re-letting risk make it equity-like and sensitive to the economy. A simple valuation is net operating income divided by a capitalisation rate, and the cap rate moves with real rates, expected rent growth and a risk premium for illiquidity and cyclical exposure. In a slowdown vacancies rise, rents fall and cap rates may widen, so value falls through both income and discount rate. The trap is treating a rise in cap rates as neutral for owners; with income unchanged, it lowers value.
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