N°24-91: Determinants of Discount Rates, Capitalization Rates, and Growth Rates

We make use of a rich database for the commercial real estate market in the U.S. that covers a long time period (2002-2024) and over 60 metropolitan markets to analyse the determinants of key inputs for the discounted cash flow or the direct capitalization approaches. Our main focus is on discount rates and capitalization rates, but we also study the factors affecting the implied growth rate of the net operating income. Given that the figures are appraisal-based, we use a common desmoothing approach to lower the degrees of serial correlation in the data. Beyond differences across property types, the discount rate in gateway markets is 89 basis points lower on average than in non-gateway markets. A similar difference is observed for capitalization rates (93 basis points). Inflation has an immediate negative impact on capitalization and discount rates due to the delayed adjustment of the rental income, but the effect turns positive over time. With a lag, real GDP growth reduces both rates, as expectations of economic growth reduce risk premia. Real interest rates consistently increase capitalization, discount, and growth rates through higher borrowing costs and portfolio reallocations. The results of this study should provide important information to appraisers and policy makers.