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An Honest Capitalization Rate

rulesmini1The capitalization rate at which a property is offered depends on the accurate calculation of net operating income (NOI) which is in turn dependent on an accurate report of the expense and vacancy ratio (EVR). Data generally available provides an easy way to calculate the reported EVR for every building in the market.

The graph above illustrates an ordered list of reported EVRs for 1000 buildings in San Francisco. The well-informed investor should analyze the data available in either a list plot as above or as a probability distribution such as shown on the right.

rulesmini2The proper use of data and econometric tools are essential to understanding a market. The vast majority of these properties have an EVR between 25% and 45%. This is a first indication that the claim the building can be operated on less than 25% expenses and vacancy may not be true.