A Cross Sectional Analysis of Cap Rates by MSA
 

Abstract:

Much attention has been paid to capitalization rates or “cap rates” defined as the net operating income over transaction price, also known as a “going-in” current yield on commercial real estate when calculated at the time of purchase. We know that there are a number of global factors that drive capital markets and required rates of return that help to explain observed cap rates over time, but we know little about factors driving the geographical cross-sectional variation of these cap rates. Why are cap rates for similar sized and type property so much lower or higher in one metropolitan statistical area than another? Using data from Real Capital Analytics for multifamily properties we explore several models that combine the expected influences from housing demand growth, supply constraints, liquidity risk and the interaction of these. We document a very strong and robust relation between supply constraints and cap rates as well as evidence of capital flowing from larger markets to smaller markets in recent years.  We also find weak but generally supportive evidence of influences from expected growth rates, liquidity and other risk factors.