What is a potential effect of increasing interest rates on cap rates?

Increasing interest rates generally lead to a rise in cap rates. The cap rate, which is the ratio of net operating income (NOI) to the property’s value, reflects the return that investors expect on their investment in commercial real estate. When interest rates rise, borrowing costs for investors also increase, which can lead to a decrease in property values.

Higher interest rates can prompt investors to seek higher returns, which often results in increased cap rates. This dynamic occurs because as it becomes more expensive to finance properties, investors may demand a greater return to compensate for the higher cost of debt. Consequently, the valuation of the properties must adjust to reflect this risk and the increased expected rate of return, resulting in higher cap rates.

The other choices suggest effects that do not align with the typical market behavior observed during periods of rising interest rates. While cap rates remaining unchanged, decreasing, or stabilizing could hypothetically occur under different economic conditions, they do not accurately represent the common trend seen with rising interest rates.