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  #1  
Old 05-28-2005, 11:41 AM
xm39hnu xm39hnu is offline
 
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I just completed AI's 510 course in advanced income cap. When I took 310 a couple of years ago, it was the roughest week-long course I'd ever endured. This includes some pretty tough courses in the avaiation field needed to achieve an Airline Transport Pilot's certificate for Rotorcraft/Helicopters. But I'm afraid I've met my match. 510 kicked my azz off.

It will be a major miracle if I passed that test. There were a half-dozen questions which ended with "What is the value of the property?" I could not affirmatively answer a single one of them. But I did manage to pick up a little better understanding of how to support yield rates, partitioning IRR, sensitivity analysis, and a bunch of other neat stuff that I won't be able to put to immediate use here in rural Tennessee.

Spent about 60% of my time fighting that (*&*&%^^ HP12-C calculator. There's an algorithm in its firmware which always produces a wrong answer first, forcing you to recalculate the problem. Why, why, why do purveyors of modern analysis techniques force you to use an antique calculator to solve problems better analyzed on a spreadsheet?

I asked that question to one of the instructors. He said that in one recent class, four of the students had worked for a CG who didn't even own a spreadsheet program!!! Talk about a one-legged man in a butt-kicking contest! IMO, one whose primary business is commercial appraisal should have two essential skills: A thorough knowledge of his word processor's advanced capabilities, and a thorough knowledge of how to operate a spreadsheet. Macro programming would be a good bonus skill to have.

I just [know] I'm gonna have to re-take that course.
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Old 05-28-2005, 03:05 PM
Jim Bearden Jim Bearden is offline
 
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After my degree at the University of Denver in Real Estate and Construction Management, my cap theory course allowed me to sit for AI tests (cap1 and cap2) and 25 years of commercial appraisal experience including over 1 million square foot office buildings all I can say is DCF is the most worthless POS method to value anything other than an outhouse.

Blasphemy maybe but since I can prove it there it is.

First USPAP course in early 90's in Los Angeles some smart ass from FDIC says they won't accept anything without DCF. That set me off and tried to argue but it was taking to much time so moved on. During a break this fellow that worked for one of the big eight accounting firms came over to discuss DCF and brag about his big project from a couple years previous the ARCO Tower in downtown LA which was one of the largest purchases in the country at the time.

After he bragged about it I asked if he used a DCF in the valuation to which he proudly said yes. I then asked if any of the DCF data and calculations ever came true. He hung his head said no and walked away with his tail between his legs. The area was in a recession and prices were coming down so I knew the answer before it was asked.

The genesis of DCF was insurance companies who ran DCF to determine if the real estate would provide them with an adequate return and used resonable expectations not the BS that is out there now.

If anybody can prove in advance how this system really works by predicting the future please give us all stock tips so we can all retire.
  #3  
Old 05-28-2005, 03:40 PM
PL1957 PL1957 is online now
 
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Quote:
Originally posted by Jim Bearden@May 28 2005, 03:05 PM
After my degree at the University of Denver in Real Estate and Construction Management, my cap theory course allowed me to sit for AI tests (cap1 and cap2) and 25 years of commercial appraisal experience including over 1 million square foot office buildings all I can say is DCF is the most worthless POS method to value anything other than an outhouse.

--------

If anybody can prove in advance how this system really works by predicting the future please give us all stock tips so we can all retire.
I always though that the appraiser's job was essentially to mimic the market's behavior in valuing real estate. If a typical purchaser would look at a property using a DCF, so should the appraiser.

I don't think anybody really expects DCF assumptions to play out accurately over the holding period, but they do expect their assumptions to mirror investor requirements.
  #4  
Old 05-28-2005, 08:08 PM
xm39hnu xm39hnu is offline
 
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Quote:
Originally posted by Jim Bearden said...
DCF is the most worthless POS method to value anything other than an outhouse.
You mean you can support a yield rate on an outhouse? And a reversion forecast?

I've long held that there's nothing complicated about a DCF analysis, mathematically. Couldn't get the d*mned HP-12C to work reliably using the DCF keys, so I had to work about six DCF problems using the basic formula and elementary algebra. But how does one support the assumptions on which cash flow forecasts are based? Where do you get your data (and how reliable is it) for population growth, economic base expansion or contraction, or even the basic economy after 5 years? Giving AI its due, none of the problems presented were projected beyond having a going-out rate based on year 6 projected cash flow. Seems to me it would be hard enough to prove the basis for five years' projections, let alone the 10 or 15 I've heard some guys talk about.

Jim, I'm glad you committed heresy. You just confirmed one of my basic concerns about this method. I think it is as reliable as the forecasts, which aren't. (BTW, if the PV of the outhouse is $0, and so is the reversion, with no income stream, the DCF oughta work OK, right?)
  #5  
Old 05-28-2005, 09:22 PM
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Couch Potato Couch Potato is offline
 
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Quote:
Originally posted by Jim Plante@May 28 2005, 09:08 PM
(BTW, if the PV of the outhouse is $0, and so is the reversion, with no income stream, the DCF oughta work OK, right?)
Your assumption on the PV of the outhouse would depend on the availability of alternative facilities and it may or may not have an income stream.
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  #6  
Old 05-28-2005, 10:27 PM
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George Hatch George Hatch is offline
 
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When DCFs really come in handy is when the cash flows are irregular or are of limited duration or involve a funky reversion (or no reversion).
  #7  
Old 05-29-2005, 05:06 AM
George K. Cox, MAI, SRA George K. Cox, MAI, SRA is offline
 
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Quote:
Originally posted by PL Norusis@May 28 2005, 03:40 PM
I always though that the appraiser's job was essentially to mimic the market's behavior in valuing real estate. If a typical purchaser would look at a property using a DCF, so should the appraiser.

I don't think anybody really expects DCF assumptions to play out accurately over the holding period, but they do expect their assumptions to mirror investor requirements.
I must agree with Jim Bearden on the DCF lending little, if any, credibility to the development of market value opinions.

“As every real estate professional knows, total return from a real estate investment is made up of several or all of the following:

 An annual cash flow return;
 Tax savings arising from depreciation deductions and other nonncash write-offs;
 Equity buildup due to mortgage amortization; and
 Gain upon resale of the property.

DCF analysis treats all of these profit elements in exactly the same way. That is, in
each case future dollars are valued at less than present dollars, but no regard is paid to the differences in risk among the types of returns.” Sanders H. Kahn, PhD, SREA

Furthermore, assuming the appraiser is attempting to follow market actions, if recent comparable sales are employed in the analysis, does the RO not take into account all of the anticipations of the future, if the buyers are using DCF analysis in their motivation to purchase?

If this be the case, why not simply use the RO?



George K. Cox, MAI
  #8  
Old 05-29-2005, 09:18 AM
xm39hnu xm39hnu is offline
 
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Quote:
Originally posted by George Cox said...
"DCF analysis treats all of these profit elements in exactly the same way. That is, in each case future dollars are valued at less than present dollars, but no regard is paid to the differences in risk among the types of returns.” Sanders H. Kahn, PhD, SREA

Furthermore, assuming the appraiser is attempting to follow market actions, if recent comparable sales are employed in the analysis, does the RO not take into account all of the anticipations of the future, if the buyers are using DCF analysis in their motivation to purchase?
Dr. Kahn's statement isn't exactly true, although it's close. Yield cap does use two different yield rates where appropriate, as does MIRR.
Quote:
If this be the case, why not simply use the RO?
How does one use the Ro on proposed construction when income is negative in the first years? Would you level the income stream over the holding period, and use that? Seems inaccurate to my semi=trained eye, and even more rife with potential for abuse.

I think DCF has its place, but only within the period in which economic conditions can be reasonably forecast. The textbooks call this the "near term," and define it to be five years or less. Long term economic forecasts are the province of professional economists, whose projections are more likely to be wrong than right. Long term DCF, then, would not only require one to be a professional economist, but would also require that his projections be correct more often than not.

For most purchases of existing property, I think extraction of the Ro from comparable sales would be more likely to reflect market preferences, and would yield the most accurate results. DCF is a tool, and only a tool. One does not use a good wood chisel as a pry bar or screwdriver. Neither should he use DCF when Ro is more likely to give better results, and vice-versa.
  #9  
Old 05-29-2005, 10:39 AM
Jim Bearden Jim Bearden is offline
 
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Quote:
Originally posted by George Hatch@May 28 2005, 10:27 PM
When DCFs really come in handy is when the cash flows are irregular or are of limited duration or involve a funky reversion (or no reversion).
Vey true this is probably the the most valid use.

I must admit that I was surprised by the responses, thank you. I really expected to be hanging from that tree next to the outhouse. :lol:
  #10  
Old 05-29-2005, 01:16 PM
PL1957 PL1957 is online now
 
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Quote:
Originally posted by George K. Cox@ MAI, SRA,May 29 2005, 05:06 AM
Furthermore, assuming the appraiser is attempting to follow market actions, if recent comparable sales are employed in the analysis, does the RO not take into account all of the anticipations of the future, if the buyers are using DCF analysis in their motivation to purchase?

If this be the case, why not simply use the RO?



George K. Cox, MAI
While the Ro does take in all factors, it does so by including most assumptions implicitly. The purchaser's assumptions regarding income growth, expense growth, tenant turnover, above/below market rents, etc. are all included in their selection of an Ro, but are not transparent to the analyst. When the DCF is used, all of these assumptions are explicit and may be examined individually for their reasonableness.

All other factors being equal, I would prefer relying on an Ro. However, relying solely on the Ro without examination of future cash flows can result in an overly simplistic analysis with a misleading valuation. If future cash flows are regular, the Direct Cap and DCF will likely be similar. If they are not, the DCF is a useful and valid method for analysis.
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