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A Simplified Approach to Understanding Capitalization Rates
by: Young W. Chai
Capitalization rates have become an important indicator of real estate market conditions. This article focuses on the expected income growth component of the capitalization rate. In analyzing data from investment advisors, expected income growth rates were found to be highly correlated with expected CPI inflation rates derived from an interest rates series. Surprisingly, expected income growth rates were not found to be as sensitive to real estate market imbalances or to historical income growth rates. Based on these findings, one might conclude that the conventional valuation of commercial real estate is driven more by inflation expectations than by fundamental conditions in the real estate markets.
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