The “smart” MBA money knows that assets are priced based on the present value of future cash flows discounted at an appropriate risk premium. There is no mention in real estate finance textbooks of adding a premium for irrational exuberance or too much money chasing too few deals.

Then we witness two asset bubbles expand and burst in less than 10 years. Now a few academics are excitedly discussing behavioral economics which allow for investor sentiment and transaction volume to distort asset pricing.  

During 2011 we saw the “smart” money once again chasing technology start-ups and overpriced commercial real estate property in select cities like New York, Washington, and San Francisco.

A leading real estate broker recently told me that if commercial real estate investors are happy with a 5 cap for office assets in Boston, then a 7 cap in his regional city should be a bargain.

Really?! You would have thought that the appropriate cap rate is equal to: Treasury Rate + Tenant Credit Risk Premium + Liquidity Premium – Growth Rate Allowance. In his regional city there was zero liquidity and probably negative growth due to in-place above market rents and high vacancy rates. How about real estate investors in said city demanding a 9 to 10 cap?