Since I posted my article on cap rates several weeks ago, I came across an October 2024 paper by Professor Peter Linneman of Wharton Business School titled "Cap Rates and Treasuries: A New Perspective."
With lots of genuine respect and admiration for both Wharton (I am a graduate of University of Pennsylvania Law School) and for Professor Linneman, it's a perfect example of why so much academic finance, while rigorous, is practically useless.
Even Professor Aswath Damodaran of NYU — one of the most respected voices in finance — has often been critical of how much of the academic literature offers little practical value to practitioners. On this, I'm entirely in agreement.
The logic in Linneman's paper is flawless: convert NOI to "cash-flow NOI," assume a constant low growth rate, plug it into the Gordon Growth model — and voilà, cap rates align perfectly with valuation.
The only problem? That's not how real estate actually works.
- Practitioners don't convert NOI to "cash-flow NOI"
- Growth isn't constant or low — it's cyclical, uneven and market dependent
- Properties age. Maintenance capex rises just as rents flatten and new buildings enter the market
If you're going to make all those assumptions anyway, you might as well just run a proper DCF — which, by the way, is a lot easier for real estate than for most operating businesses.
Theory is elegant. But buildings leak, boilers fail, tenants move out, and interest rates move in unpredictable ways — none of which fit neatly into a perpetuity model.