1.

1INDUSTRY PROFILE:

US Real Estate Industry:

Real estate in United States is one of the largest markets in the world. In fact, it is so significant to world
economic activity that the availability of easy money and the subsequent Housing Bubble triggered the Sub-
Prime Crisis and eventually the global Financial Crisis of 2008 - 2009 that brought the world's economy to its
knees. The US real estate market is divided into 2 sectors: commercial real estate and residential real estate.
Most discussion tends to focus on residential real estate (i.e. houses), but commercial real estate is also a
critical sector of the economy, and is made up of offices, shopping malls, factories, warehouses and other
commercial buildings.

In order to be successful in real estate investment, an investor needs to understand house price trends, assess
the condition and value of the investment property, and secure a suitable mortgage or other form of real
estate finance. The US real estate industry has been experiencing wonderful growth due to the relatively
steady good economy. In 2006, some markets had major gains in occupied space, others saw record sales
transactions. The market has begun to tighten, developers remained cautious possibly eye toward the future,
particularly predictions of escalating rental rates.

Major Participants in the Real Estate Industry

Developers
Development is an idea that comes to fruition when consumers – tenants or owner- occupants acquire
and use the space put in place by the development team. Land, labor, capital management and
entrepreneurship are needed to transform an idea into reality. Developers balance the needs of diverse
providers and consumers of the real estate product. The developers have to demonstrate the project's
feasibility to the capital markets and pay interest or assign Equity positions in return for funding.

Appraisers
Appraisers can be a part of every stage of the property development process. Appraisers are primarily
responsible for valuation of the project. They estimate the market value of the property and typically prepare
a formal document called appraisal. Appraisal may be necessary when a developer transfers ownership, seeks
financing and credit, resolves tax matters, and establishes just compensation in condemnation proceedings.
Appraisers can also evaluate a project as input to market studies and feasibility studies. Some of the familiar

1
names in the US Real Estate markets include CB Richard Ellis, Cushman and Wakefield and Grubb and
Ellis.

Property managers
Property managers focus on the day operation of the asset. Property managers carry responsibility for
all respects of the physical space in accordance with the asset manager's plan. The responsibilities of a
property manager include:
• Marketing and leasing
• Maintenance and repair
• Tenant relations including rent collection
• Insurance
• Accounting
• Human resource management
• Providing timely information to the asset manager about events affecting the property.
Some of the major property managers include Trammel Crow Company and Grubb and Ellis Company.

Brokers/ Leasing Agents

Real Estate brokers and leasing agents are hired to act in the name of the developer or asset manager
in leasing and selling space to prospective tenants or buyers. Their function, particularly in leasing large
industrial and commercial spaces is to carry out one of the most complex financial negotiations in the
development process. Leasing agents must balance all the various uses' individual needs against the
developer's financial model.

Lenders
A) Construction Lenders are usually commercial banks, which are responsible for financial during
project construction and for seeing that the developer completes the project within the budget and according
to the specifications.

B) Permanent lenders seek to originate safe loans generating the maximum possible return. The
market value of the completed project is very critical in that it serves as the primary collateral for the loan.

2
1.2 COMPANY PROFILE:
Zenta Knowledge Services Pvt. Ltd.,

About Zenta:
Zenta which is founded in 2001 is a world-class knowledge process outsourcing (KPO) and business process
outsourcing (BPO) and Company, offering a full range of back-office, voice and on-site support solutions
such as Credit Card Servicing, Consumer Lending Servicing, Accounts Receivable Management, Mortgage
Servicing and Real Estate Capital Market Analytics. The Company serves in the area of Consumer Credit
services, Insurance and Financial Services, and Commercial and Residential Real Estate services. With
4,500+ employees worldwide, Zenta has operations in six locations across three continents. Zenta is a
preferred employer in India. Zenta pioneered the concept of developing and delivering higher level offshore
solutions for the real estate industry. The unique onshore/offshore approach combines US domain expertise,
a proven process migration methodology and a large team of highly trained offshore finance professional.
Zenta allows the clients to focus on their core business by utilizing its cost effective resources and scalable
platform to execute non- core activities.

Vision & Mission

The May 2007 realignment of the Company’s services under the Zenta brand reflects the new corporate
vision of building a world-class Knowledge and Business Process Outsourcing Company focused on the real
estate and financial services industries. As a fully integrated global enterprise, Zenta now offers real estate
and financial services customers a broad array of services from its centers of excellence around the globe.

Zenta Solutions
From origination and throughout the customer lifecycle, Zenta delivers deep, end-to-end servicing solutions.
Zenta's specialized focus on the financial services industry and our management expertise and experience,
are the reasons we have been chosen to provide high-end business processing for some of the world's most
prestigious banks and financial institutions. Instead of coordinating multiple vendors, Zenta's complete
solution set makes it possible for clients to work with one company only - providing a single source for all
their business processing needs. Zenta's end-to-end solutions include Credit card servicing and Commercial

3
Realty Services, Residential Realty Services and Account Receivables management, Healthcare Revenue
Cycle Management and Residential Mortgage Services.

Zenta’s executive, client facing and management teams are based in the U.S. and are comprised of leaders
with deep and broad industry expertise from top Fortune 1000 companies. They deliver the depth of
experience necessary to build long-term, strategic relationships with our clients and provide easy access to
Zenta's decision-makers. In addition, an experienced delivery team has extensive expertise in operating
global delivery centers while adhering to the highest industry and quality standards.

Zenta believes in long-term partnerships - but with flexible engagement models. Put simply, we partner with
clients to transform the way they do business. As the global operating model gains momentum, we help
clients meet their business challenges by designing and implementing complex solutions that deliver rapid
and enduring savings, allow clients to quickly introduce new products or services, augment highly skilled
internal resources and minimize large-scale investments. We believe these accomplishments will be achieved
through the innovative ways in which data is captured, collated, analyzed and disseminated.
Our proven ability to scale rapidly, both in volume and skill sets, enables us to create high-impact programs
for our clients. We engage with clients at the early stages of their offshoring program to develop an offshore
"roadmap" that best meets their objectives. Furthermore, we build flexible client relationships and have
experience working on a variety of engagement models.

1.3 CAPITALIZATION RATE:

The capitalization rate in the real estate literature refers to the ratio of Net Operating Income to
property value which is the inverse of the price earnings ratio in the stock market. This rate has a particularly
important role in property valuation, because the income capitalization method converts the expected income
stream from commercial property into an estimate of asset value by dividing the net operating income stream
by the capitalization rate. Most investors associate movements in cap rates with changes in asset values, e.g.,
falling cap rates signal rising property values-changes in income or asset prices (or both) can cause cap rates
to move up or down. This is because there is a positive correlation between the property income and the asset
values, the movements in one variable frequently dilute the cap rate effects of movements in the other. For
example, when rents (income) are rising, property values also tend to increase, such that both the numerator
and denominator of the cap rate equation increase; and when rents are falling, property values usually fall,
although this has not been the case for the last few years.

4
 A market cap rate is determined by evaluating the financial data of similar properties which have
recently sold in a specific market. It provides a more reliable estimate of value than a market Gross Rent
Multiplier since the cap rate calculation utilizes more of a property's financial detail. The GRM calculation
only considers a property's selling price and gross rents. The Cap Rate calculation incorporates a property's
selling price, gross rents, non rental income, vacancy amount and operating expenses.

If we have a seller and an interested buyer for particular piece of income producing property, the
seller is trying to get the highest price for the property or sell at the lowest cap rate possible. The buyer is
trying to purchase the property at the lowest price possible which translates into a higher cap rate. The lower
the selling price the higher the cap rate. The higher the selling price, the lower is the cap rate. In summary,
from an investor's or buyer's perspective, the higher the cap rate, the better. Investors expect a larger return
when investing in high risk income properties.
The Cap rate may vary in different areas of a city for many reasons such as desirability of location,
level of crime and general condition of an area. You would expect lower capitalization rates in newer or more
desirable areas of city and higher cap rates in less desirable areas to compensate for the added risk. In a real
estate market where net operating incomes are increasing and cap rates are declining over time for a given
type of investment property such as office buildings, values will be generally increasing. If net operating
income is decreasing and capitalization rates are increasing over time in a given market place, property
values will be declining.
The cap rate (R) equals (expected) net operating income NOI1 divided by the value of the
property (V) as follows (Ellwood, 1970),

Net operating income is determined by subtracting vacancy amount and operating expenses from a
property's gross income. Operating expenses includes advertising, insurance, maintenance, property taxes,
property management, repairs, supplies, utilities, etc. Operating expenses do not include the following
Appraisers use the Income Approach, Cost Replacement and Market Comparison methods to estimate the
value of property. The Income Approach utilizes the theory of Capitalization.

The property value for determining the cap rate is based on the sales price in a competitive market
commonly called the market value. Brueggeman and Fisher (1993) noted that the cap rate is not an internal
5
rate of return on investment (IRR) because it does not consider changes in projected future income (or
changes in the value of a property over time because of changes in the income stream). If the income stream
is expected to grow at a constant growth rate (g) into the foreseeable future, Brueggeman and Fisher (1993)
show that the value of a property is estimated as the present value of a perpetual stream of future net
operating income cash flows using discount rate r:

Rearranging equation, the cap rate equals the total required return on the property less the expected growth
rate as given:

The 3 Major determinants of cap rates are,

(1) The Opportunity Cost of Capital (OCC),
(2) Growth Expectations in the property’s future cash flows, and
(3)Risk perceptions and preferences among investors regarding the property

The following table shows the movement of capitalization rate for 1992-2010. These movements are due to
various factors which internally or externally affect the property. There has been initial increase over the
capitalization rate but after 2002, a decline can be noted.

Year 4Q Moving Average

1992 7.00%
1994 6.80%
1996 8.20%
1998 9.00%
2000 9.00%
2002 9.50%
2004 8.00%
2006 9.74%
2008 6.25%
2010 10.00%
Table 1.1 4Q Moving Average of Capitalization rate 1992-2010

6
 Figure 1.1 General Movement of cap rate of 4Q from 1992 – 2010

The capitalization rate differs from property to property. It ranges from high in Retail property to low in
Industrial property. The following table provides the capitalization rate for the various property types from
2005 – 2010.

Property Type 2005 2006 2007 2008 2009 2010

Retail 9.30% 9.00% 9.00% 8.25% 7.50% 7.50%
Office 8.40% 8.75% 8.75% 8.50% 8.00% 7.50%
Multifamily 7.90% 7.60% 7.25% 5.80% 5.50% 6.80%
Industrial 8.70% 8.60% 8.50% 8.25% 7.80% 7.00%

Table 1.2 Cap rate for various property types from 2005 – 2010

7
 Figure 1.2 Capitalization rates from 2005 – 2010

1.4 FACTORS AFFECTING THE CAPITALIZATION RATE:

The major determinants of capitalization rates are as follows,

• Property Type
The Property type is the category to which it belongs. The various types of properties are Retail,
Office, Mixed Use, Hotel, Multi-family, Self storage and Industrial properties.

• Location
Location means the state in which the subject property is situated.

• Loan To Value
Loan to value is the portion of the amount borrowed compared to the cost or value of the property
purchased. A higher LTV ratio means higher leverage and thus greater risk.

• Age of the Property

The age of the property is measured as the time gap between its year built and present date.

• Mortgage Constant
The relationship between annual mortgage loan requirement and the initial mortgage loan principal
expressed as a decimal or percentage, for level payment mortgage loan.

8
• Lease Term
Lease term is the term during which the tenant agrees to stay in the property by entering into a
lease agreement with the landlord.

• Interest rate
Interest rate is the percentage of a sum of money charges for its use. It is the return on an investment.

• Discount Rate
Discount rate is rate of interest charged by Federal Reserve System to banks who borrow money
from the Federal Reserve. An increase in the rate not only discourages from borrowing but also
serves as a signal to money market that the interest rates are probably going to increase.
Accordingly, interest rates charged by banks to customers usually increases as a result of increase in
discount rate. The term is also used to explain the compound interest rate used in the approach to
value to convert expected future cash flows into present value.

• Inflation
Inflation is the loss in purchasing power of money and increase in the general price level. Generally
measured by the consumer price index published by Bureau of Labor Statistics

• Number of Tenants
Number of tenants occupied in the property is the number of tenants. It may be single tenant for the
office property and multi-tenant for the retail property.

• Debt Service Coverage Ratio

Debt service coverage ratio is the relationship between annual net operating income of a property
and annual debt service of the mortgage loan on property. Lenders and investors calculate the ratio
to assist them in determining the likelihood of the property generating enough income to pay the
mortgage payments. From lenders view point the higher the ratio the better.
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1.5 NEED FOR THE STUDY:
Property valuation forms the basis of real estate inventory decision making. Property valuation is
done not only at the time of making the inventory decision, but throughout the period of ownership of the
asset. Decisions are also made periodically about rehabilitation, modernization, expansion, conversion of the
property to another use, demolition of the existing improvements and ever abandoning the asset.

The purpose of this study is to facilitate the company to value the property in various states of US
Real Estate market using the capitalization rate which in turn enables the company to analyse and
recommend investment strategies for clients such as lending institution, bankers or owners etc through a risk
return analysis of the income streams of different commercial and Real estate properties.

1.6 SCOPE OF THE STUDY:

• The project seeks to study the various factors to be considered while estimating the capitalization rate.
• To understand the most relevant and reliable methodology for income producing properties.
• To conclude a market value for some subject property in US real estate market.

1.7 PRIMARY OBJECTIVES:

• To scrutinize the vital factors which affects the capitalization rate of the property and to find out the
importance of each factor.

SECONDARY OBJECTIVES:
• To study the impact of property type in determining capitalization rate.
• To determine the effect of location in Real estate market.

1.8 STUDY METHOD:

Description study method is chosen for the study because of the vast amount of data available in
different books, magazine and websites relating to US real estate. The focussed study of the data can give
good insight into factors influencing capitalization rate.

1.9 DATA COLLECTION:

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 For the purpose of the study, secondary data was collected through,
 The materials available about US real estate in various websites like realestatejournal.com,
realtyrates.com, bloomberg.com.
 The materials maintained in the organization about the properties.
 Research publication of other institutes and organization like REIS, PULASKI, CBRE.

2.1 LITERATURE REVIEW:

Sirmans and Webb (1978, 1980) and Ricks (1969) used the ACLI data source. They estimated
imputed equity yields on the investments by hypothesizing average holding periods with no price
appreciation and imputing tax rates. They relate the yield and its variance to alternative investments by using
only the cap rate.

Nourse (1987) uses the REIS data source to estimate the impact of change in capitalization rate for
real estate. His model, however does not take into account the potential variation driven by property types.

Evans (1990) used ACLI data source to estimate the time-series properties for capitalization rates.
His study focuses on comparing the stochastic nature of the stock market earnings/price ratio with real estate
capitalization rate.

Froland (1987) uses the ACLI data source to explain variation in capitalization rate and the
interaction of those rates with the capital market. Froland finds that the capitalization rate is a function of the
mortgage contract rate, the spread between Treasury bills and bonds and the corporate earning price ratio.
However his study has several significant problems like the impact of variation is not considered and does
not specify the relationship between the capitalization rate and the independent variables and the
interpretation of his correlation coefficients is weakened by autocorrelation present in the dataset.

11
 Guntermann and Smith (1987) derived estimates of equity rates and costs of capital for property
REITs, mortgage REITs, and homebuilders/developers. While operating properties and REITs had a before-
tax cost of capital of 16.6%, homebuilders/ developers’ cost of capital was substantially greater at 34.9%.
Their study concluded that the data sources and procedures permit the estimation of cost of capital and equity
rates with satisfactory precision and reliability for the majority of investment or appraisal applications.

12
A study by Evans (1990) noted the sensitivity of the multifamily and nonresidential real
estate cap rates to the earnings/price ratio in the stock market. This study of quarterly cap
rates for 1966–1988 reported a strong positive relation of real estate cap rates lagging the
earnings/price ratio by one period. Although short of statistical significance, a somewhat
lesser positive correlation occurred in the same quarter and a negative correlation occurred in
the second quarter. Evans concluded that these results were not consistent with the theory that
real estate markets are information efficient.

Ambrose and Nourse (1993) examined mean quarterly capitalization rates for
commercial/retail, office buildings, commercial services, industrial, and hotel properties for
1966 through 1988. The theoretical base for their study is the traditional WACC model that
has been used so extensively in the finance literature. Their empirical model related cap rates
to a local variable, the spread between long-term and short-term Government bond rates, the
earnings/price ratio of the S&P 500, and debt-to-equity components. The debt-to-equity
components were estimated from the average loan-to value and property mortgage costs.
Using seemingly unrelated regression (SUR), they reported that cap rates were not closely
tied to either the S&P 500 or the bond risk premium spread. Using a cross-sectional/time-
series regression approach, they found that Weighted cost of debt of .98, not significantly
different from one. Also, the return on equity was estimated at 4.85% and was statistically
different from zero. The intercept and slope coefficients were found to vary significantly by
property type; however, the panel data regression did not permit separate slope coefficients
by area.
The above researchers made a detailed study about Capitalization rate and have built a
various dynamic Cap rate models for the use of investors so that they can use these models to
predict Cap rates based on past information. The researchers have used ACLI and REIS data
source to estimate the impact of change in capitalization rate for US real estate industry.

2.2 Research Gap:

The above researchers made a detailed study to built Cap Rate model for the purpose of the
investors. But this current study is made to find out which of the factors have most
influential effect on capitalization rates. Unlike other studies that have used the ACLI
database, this study uses NREI database for office, warehouse/distribution, retail, and
apartment properties.

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3.1 RESEARCH METHODOLOGY:
Research Methodology is the way in which the data are collected for the research
project.

Type of Research:
In this study, the type of research is “Exploratory Research”.

Exploratory Research:-

Exploratory research is a type of research conducted for a problem that has not been
clearly defined. It helps to determine the best research design, data collection method and
selection of subjects. It should draw definitive conclusions only with extreme caution. Given
its fundamental nature, exploratory research often concludes that a perceived problem does
not actually exist.

Exploratory research often relies on secondary research such as reviewing available

literature and/or data, or qualitative approaches such as informal discussions with consumers,
employees, management or competitors, and more formal approaches through in-depth
interviews, focus groups, projective methods, case studies or pilot studies. The Internet
allows for research methods that are more interactive in nature.

The results of exploratory research are not usually useful for decision-making by
themselves, but they can provide significant insight into a given situation. Although the
results of qualitative research can give some indication as to the "why", "how" and "when"
something occurs, it cannot tell us "how often" or "how many". Exploratory research is not
typically generalizable to the population at large.

Variables Used:

• Independent Variables: The independent variable is the variable that we use to

explain a particular outcome.

Components of independent variables in this study are:

 Location

14
 Property Type

 Age of the Property

 Interest Rate

 Inflation

 Lease Term

 No of tenant

 Discount Rate

 LTV

 DSCR

 Mortgage Constant

• Dependent Variable: The dependent variable is what we are trying to explain.

 Capitalization Rate

3.2 LIMITATIONS OF THE STUDY

• The study is limited only to real estate market in certain states in U.S.A.
• The study is restricted only to vital factors which affect the capitalization rate.
• Only secondary data has been used in the study.

3.3 DATA PROCESSING:

• Type of data

 Secondary Data

• Sources

 Internal documents maintained in the company

• Research Period

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  6 years (from 2005 to 2010)

• Tools Used

 Descriptive method

 Mean

 Standard deviation

 Quantitative method

 Hypothesis Testing

 Correlation

 Regression

 SPSS software used for analysis.

HYPOTHESIS TESTING:

 Null Hypothesis (Ho1): There is no significant relationship between Capitalization

rate /dependent variable and other factors/independent variable.

 Alternative hypothesis (H11): There is no significant relationship between

Capitalization rate /dependent variable and other factors/independent variable.

16
4.1 DESCRIPTIVE ANALYSIS:

Descriptive analysis refers to mathematical methods (such as mean, median, standard

deviation) that summarize and interpret some of the properties of a set of data (sample) but do
not infer the properties of the population from which the sample was drawn. Generally the
measures of central tendency (mean, median and mode) and measures of dispersion such as
standard deviation are the tools used in Descriptive Statistics.

All the above factors that affect the Capitalization Rate are used in the Descriptive Statistics.

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 Descriptive Statistics
Std.
Mean Deviation N
Cap rate 7.47333 .922984 30
Location 8.10 5.683 30
Property Type 1.60 .675 30
Age of the
22.87 21.365 30
Property
Interest Rate 5.99000 .342566 30
Inflation 2.86667 .260415% 30
Lease Term 4.10 4.845 30
No of tenant 1.83 .379 30
Discount Rate 8.6417 1.38217 30
LTV 71.433 7.5324 30
DSCR 1.3353 .28832 30
Mortgage
7.138667 .6568931 30
Constant
Table 4.1: Descriptive Statistics for Cap Rate and Other Factors

From this descriptive statistics we can able to identify that there are some deviations in the
variables taken for analysis. Among all the factors Loan to Value (LTV) is the factor which
is highly deviated from its actual mean.

4.2 CORRELATION ANALYSIS:

Correlation determines the degree of association between two variables X, Y. A plot

of the observations generally helps to visualize whether the variables are correlated. This plot
is called as Scatter Diagram. If the observations tend to flare out or narrow it may suggest

18
that the variance over the samples is not constant.

Figure 4.1 Scatter Diagram

The correlation coefficient formula is:

r= n∑xy - ∑x * ∑y

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 √ (n ∑x2 – (∑x)2) * √ (n ∑y2 – (∑y)2)

The correlation coefficient r, a value between +1 and -1, expresses the degree of
association between X and Y.

In order to scrutinize the vital factors which affect the capitalization rate of the property, in
this study we take Capitalization Rate as a dependent Variable and all the other factors as a
independent variable.

The Output of the correlation analysis is shown in the Table 4.2

Scatter diagram showing between Capitalization rates and other Factors:

2.8
PROPERTY TYPE

2.3

1.8

1.3

0.8
0.05 0.06 0.07 0.08 0.09 0.1
Cap Rate

Figure 4.2 Correlation – Capitalization rate and Property type

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 5.5

4.5

Quantified Location
4

3.5

2.5

1.5

0.5
0.05 0.06 0.07 0.08 0.09 0.1
Cap Rate

Figure 4.3 Correlation - Capitalization rate and Location

80

70
Age of the Property

60

50

40

30

20

10

0
0.05 0.06 0.07 0.08 0.09 0.1
Cap Rate

Figure 4.4 Correlation – Capitalization rate and Age of the property

20

15
Lease Term

10

0
0.05 0.06 0.07 0.08 0.09 0.1
CapRate

Figure 4.5 Correlation – Capitalization rate and Lease term

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 0.08

0.075

0.07

Interest Rate
0.065

0.06

0.055

0.05
0.05 0.06 0.07 0.08 0.09 0.1
Cap Rate

Figure 4.6 Correlation – Capitalization rate and Interest rate

0.031

0.029

0.027
Inflation

0.025

0.023

0.021

0.019
0.05 0.06 0.07 0.08 0.09 0.1
Cap Rate

Figure 4.7 Correlation – Capitalization rate and Inflation

0.13

0.12

0.11
Discount rate

0.1

0.09

0.08

0.07

0.06

0.05
0.05 0.06 0.07 0.08 0.09 0.1
CapRate

Figure 4.8 Correlation – Capitalization rate and Discount rate

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 0.09

Mortgage Constant
0.085

0.08

0.075

0.07

0.065

0.06

0.055

0.05
0.05 0.06 0.07 0.08 0.09 0.1
CapRate

Figure 4.9 Correlation – Capitalization rate and Mortgage Constant

0.9

0.85

0.8

0.75

0.7
LTV

0.65

0.6

0.55

0.5

0.45

0.4
0.05 0.06 0.07 0.08 0.09 0.1
Cap Rate

Figure 4.10 Correlation – Capitalization rate and Loan to Value

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 2.2

1.8

DSCR
1.6

1.4

1.2

1
0.05 0.06 0.07 0.08 0.09 0.1
Cap Rate

Figure 4.11 Correlation – Capitalization rate and DSCR

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Interpretation:
In the table 4.1, we can see four factors (Age of the Property, Inflation, Lease Term and
LTV) are negatively related with Capitalization Rate. And the Remaining Factors (Location,
Property Type, Interest Rate, No of Tenant, Discount Rate, DSCR and Mortgage Constant)
are positively related with Capitalization Rate. But seeing the significance level, only four
independent variables (Age of the Property, Interest Rate, Discount Rate and Mortgage
Constant) have significance level below 10%. Remaining Seven independent variables have
significance level more than 10%.

Therefore considering the significance level, only the below mentioned four independent
variables are considered for regression analysis.
• Age of the Property
• Interest Rate
• Discount Rate and
• Mortgage Constant
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4.2 MULTIPLE LINEAR REGRESSION ANALYSIS:

Multiple linear regressions are used to predict the variance in an interval dependent,
based on linear combinations of independent variables. Multiple regression can establish that
a set of independent variables explains a proportion of the variance in a dependent variable at
a significant level (through a significance test of R2), and can establish the relative predictive
importance of the independent variables. One can test the significance of difference of two
R2's to determine if adding an independent variable to the model helps significantly. Using
hierarchical regression, one can see how most variance in the dependent can be explained by
one or a set of new independent variables, over and above that explained by an earlier set.
The estimates (b coefficients and constant) can be used to construct a prediction equation and
generate predicted scores on a variable for further analysis.

The multiple regression equation takes the form y = b1x1 + b2x2 + ... + bnxn + c. The b's
are the regression coefficients, representing the amount the dependent variable y changes
when the corresponding independent changes one unit. The c is the constant, where the
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 regression line intercepts the y axis, representing the amount the dependent y will be when all
the independent variables are 0. Associated with multiple regression is R2, multiple
correlation, which is the percent of variance in the dependent variable, explained collectively
by all of the independent variables. Multiple regression shares all the assumptions of
correlation: linearity of relationships, the same level of relationship throughout the range of
the independent variable, interval or near-interval data, absence of outliers, and data whose
range is not truncated. Here,
R2 - coefficient of determination, gives the proportion of the variance of one variable that is
predictable from the other variable.
Standard Error - The standard error of a statistic is the standard deviation of the sampling
distribution of that statistic.

F-Ratio – F-ratio is the test statistic used in analysis of variance to compare the magnitude of
two estimates of the population variance to determine whether the two estimates are
approximately equal.
Significance Level - The probability of a false rejection of the null hypothesis in a statistical
test.

Multiple linear regression analysis is done using SPSS. As discussed earlier only the below
mentioned factors are considered for regression analysis.
Dependent variable : Capitalization rate
Independent variables : Age of the Property, Interest Rate, Discount Rate and
Mortgage Constant.

Multiple Regression Results:

Model Summary
Change Statistics
R Adjusted R Std. Error of R Square Sig. F
Model R Square Square the Estimate Change F Change df1 df2 Change
1 .644a .415 .321 .760519% .415 4.428 4 25 .008
Table 4.3 Regression Statistics – Model Summary

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 The coefficient of determination of R square is 0.415; therefore, about 41.5% of the variation
in the dependent variable is explained by independent variable. The regression equation is
not very useful for making predictions since the value of r is not close to 1.

ANOVAb
Sum of
Model Squares df Mean Square F Sig.
1 Regression 10.245 4 2.561 4.428 .008a
Residual 14.460 25 .578
Total 24.705 29
Table 4.4 Regression Statistics – Anova

A one-way between subjects ANOVA was conducted to know which of the four factors affect
the capitalization rate. Looking at the Sig value in the last column, it is only 0.8% i.e. it is
less than the significance level of 10%. Hence H0 can be rejected and H1 can be accepted.
So therefore we can say that there is significant relationship between Capitalization rate and
other factors.

Coefficientsa
Standardize
Unstandardized d
Coefficients Coefficients Collinearity Statistics
Model B Std. Error Beta t Sig. Tolerance VIF
1 (Constant) 2.298 2.546 .902 .375
Age of the
-.011 .007 -.254 -1.627 .116 .964 1.038
Property
Interest Rate .137 .495 .051 .277 .784 .694 1.442
Discount Rate .338 .108 .506 3.114 .005 .887 1.127
Mortgage
.236 .254 .168 .930 .361 .718 1.393
Constant
Table 4.5 Regression Statistics – Coefficients

From the above output, the regression equation is:

Capitalization Rate = 2.298 - .011Age of the Property + .137 Interest Rate + .338 Discount
Rate + .236 Mortgage Constant

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Looking at the above Coefficient table, P value for the age of the property, Interest Rate and
Mortgage Constant is greater than significance level (0.375, 0.116, 0.361 > .10). Hence we
can conclude that there is no significant relationship between Capitalization rate and Age of
the Property, Interest Rate and Mortgage Constant.

But there exists enough evidence to conclude that for the Discount Rate alone P value is less
than the significance level of 10% (0.005 < .10). So therefore we can say that there is
significant relationship only between Capitalization rate and Discount Rate.

5.1 FINDINGS:

By analyzing the various factors affecting the capitalization rate the following were observed:

• It is observed from the 4 quarter moving average that for the past 10 years the
capitalization rates for the properties are showing a downward trend. This means the
value of the properties is continuously increasing.

• From the descriptive statistics, it is found that there are deviations in the variables
taken. Among the eleven variables it is clear that Loan to value has deviated highly
for about 7.5324 from its actual mean 71.433.

• The independent variables and dependent variable are significantly correlated .Among
independent variables: Age of the property, Inflation, Lease Term and Loan to value
are negatively correlated and the remaining factors are positively correlated with the
Capitalization Rate.

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 • Only four factors (Age of the Property, Interest Rate, Discount Rate and Mortgage
Constant) are considered for regression analysis since their sig value is alone less than
10% significance level.

• The independent variables explain 41.5% of dependent variable (Capitalization Rate)

at 0.8% level of significance which is less than 10% level of significance.

• The coefficient interpret that there is negative association between Age of the
Property and Capitalization Rate, and there is positive association between Interest
Rate, Discount Rate and Mortgage Constant and Capitalization Rate.

• The model of this analysis explains only Discount Rate has slight influence on
capitalization Rate at 10% significance level and all the other factors doesn’t have any
influence on capitalization rate.

5.2 SUGGESTIONS:

Since Investors are the one in Real estate market who consider capitalization rate as
an important element to estimate the reversionary value of the subject property. The
following suggestions are made from the investors’ point of view:

• Investors should not only consider Discount Rate but should also consider the
other factors such as Property type, Location and Market while investing in
the Real Estate Market.

• Investors should take into consideration the per capita income while deciding
the location of the property.

• The investors should consider the lease term while investing in properties as
very low lease term leads to roll over risk and higher cost of tenant
improvements.
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 • The investor must consider the property type as some properties such as hotels
are more risky due to unpredictable occupancy rate.

• The investors can use the regression model developed in this study to estimate
the capitalization rate of the property.

5.3 CONCLUSION:

A capitalization rate is simply a ratio of a property’s net operating income (NOI) to its
Property value, much like the inverse of a price earnings ratio in the stock market. Given the
limited number of properties that actually sell in a period, changes in simple average cap rates
from period to period are unlikely to reflect accurately what is happening to real estate values
per dollar of income.

The results from this study indicate that only one factor has a slight impact in
evaluating capitalization rates. This may not be true for all the time. Factors that seem
important today may become outdated and irrelevant after few years. This is a dynamic,
competitive, and highly complex industry. The framework of factors presented in the text will
indubitably help the investors to achieve their set objectives, gain a competitive advantage,
and maximize the return on the real estate property. Real estate capitalization rates have
plunged amid fierce competition for core assets with secure and predictable cash flows. The
real estate industry is capital intensive and relies heavily on debt.

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5.4 DIRECTIONS FOR FUTURE RESEARCH:

 This study can be made in some other organisations belonging to KPO Industry.

 This same study can be conducted by using various other Techniques like sampling,
probability, etc

 After scrutinising the important factors that affect the Capitalization Rate, a separate
dynamic cap rate model can be built for the investors’ purpose.

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CLASSIFICATION OF DATA:

Property Classification
Classification of Property type - Based on risk in that property

Property Type Rank

Hotel 3
Office / Retail 2
Industrial / Mixed
Use / Multifamily / 1
Self storage

Location and Market Classification

Classification for Location and Market - Based on per capita income of the County

Per Capita Income Rank

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 Less than $25,000 5
$25,000 - $50,000 4
$50,000 - $75,000 3
$75,000 - $1,00,000 2
More than $1,00,000 1

BIBLIOGRAPHY

Books Referred:

• Business statistics – C.B.Gupta

• Research methodology – C.R. Kothari

Research Papers

• Journal of Real Estate Research: Ambrose, B. and H.O. Nourse. 1993. Factors

Influencing Capitalization Rates.

• Journal of Real Estate Research: Evans, R. 1990. A Transfer Function Analysis of

Real Estate Capitalization Rates.

• Journal of Portfolio Management: Froland, C. 1987. What Determines Cap Rates on

Real Estate.

• Journal of Real Estate Research: Jud, D., and D. Winkler. "The Capitalization Rate of

Commercial Properties and Market Returns."

Websites:

• www.zenta.com

• www.cbre.com

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• www.pulawski.com

• www.realestatejournal.com

• www.realtyrates.com

• www.census.gov

• www.reis.com

• www.ncreif.com

• www.bloomberg.com

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