Explain which economic forces drive private property values and what the asset class contributes to a portfolio
The idea
Demand comes from GDP and employment for offices, population and household formation for housing, consumer spending for retail, and trade and e-commerce for logistics. Supply reflects construction and planning limits. Value = NOI ÷ cap rate, and the cap rate moves with interest rates and expected rent growth. A property with NOI of 5 at a 5% cap rate is worth 100. If the cap rate rises to 6% the value falls to about 83.3, a loss of roughly 16.7% with no change in income. In a portfolio, real estate supplies income, some diversification from stocks and bonds, a partial inflation hedge and the potential for capital growth. The trap: long fixed-rent leases give little inflation protection until they reset.
Formulas
Property value from income
value = NOI ÷ cap rate
- NOI
- net operating income: rent less operating costs, before financing and tax
- cap rate
- the capitalisation rate the market applies to that income
Value is very sensitive to the cap rate: a rise from 5% to 6% cuts value by about a sixth with income unchanged. Cap rates move with interest rates and expected rent growth.
In the app: 2 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
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