Transaction-Based and Appraisal-Based Capitalization Rate Determinants

This paper provides a contribution to the discussion on appraised values vs. transaction prices by comparing the driving factors of appraisal-based capitalization rates with those of transaction-based capitalization rates. Using a rich database of real estate transactions in Switzerland for the period 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. 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, it helps to explain the appraisal-smoothing phenomenon, as the easily observable factors hardly change over time, while the latter variables do change frequently and significantly. Second, investors put less emphasis on factors that are diversifiable, which suggests that they have a portfolio perspective, whereas the focus of appraisers is more on the individual property level.