Transaction-Based and Appraisal-Based Capitalization Rate Determinants

This paper contributes to the debate about capitalization rate determinants by comparing the driving factors of appraisal-based cap rates with those of transaction-based cap rates. By using a rich database of real estate transactions in Switzerland for the period of 1985-2010, we identify several property-specific variables that have not been used in prior research and that increase the explained portion of the cap rate variance by as much as 10 percentage points. The results show that compared to investors, appraisers overweight factors that they can easily observe when they appraise a property, at the cost of variables related to growth expectations and the opportunity cost of capital. This has two implications. First, as the easily observable factors hardly change over time, while the latter variables change frequently and significantly, it provides new evidence that may add to the appraisal-smoothing discussion. Second, investors put less emphasis on factors that are diversifiable, which suggests that they favor a portfolio perspective, whereas the focus of the appraisers is more on the individual property level.