Abstract: Capitalization Rates represent the ratio of NOI to price for real estate assets

Empirical data and previous research have shown that capitalization rates vary across different MSA markets as well as between different product types. The cause of these variations is not fully understood however. Theory would suggest that the cause of variation should be income growth expectations, or risk variation. Surprisingly, ex-post data comparing income growth and cap rates shows almost no correlation between cap rates and ex-post income growth. This data suggests that the market is somehow inefficient, or that the market has historically done a poor job of anticipating future income changes. This paper will further explore capitalization differences across markets by exploring several different proxies for future income growth including historic rental growth, anticipated rental growth based on Torto Wheaton data, and ex-post actual rental growth. The intent of this research is to develop a better understanding of how the market prices risk and future rent growth expectations. A better understanding of these factors will hopefully lead to the development of an investment strategy that will capitalize on the market inefficiencies and poor ability to predict future income growth.