Estimation of NOI Growth, Volatility and Clustering by MSA

Returns for commercial real estate are determined by the interaction between the market for space or "space market" and the market for capital or "capital market." In the space market, tenants lease space and short run rental rates are determined by the supply and demand for space. Discount and capitalization (cap) rates for rental real estate are determined in the capital market where real estate competes with other investment alternatives for capital. Uncertainty as to what rental rates and the resulting net operating income (NOI) will be for a property affect risk premiums that are included in the discount rate (See Fisher, Hudson-Wilson and Wurtzebach, 1993; and Fisher, 1992). The space market tends to be local in nature as supply and demand for space can vary considerably across locations. The capital market tends to be more national and little variation in discount rates from location to location (although capitalization (cap) rates will vary due to differences in expected growth in NOI).