Developing a discount rate

[Ken B]

Sorry to ask, but my brain is fried and it is having a hard time getting around the answer to this question.

I am doing a subdivision development analysis. Forecast unit prices are stable, forecast costs are increasing 2.75% annually.

Have a discount rate, trying to support it through a cap rate. Cap rate is well supported by DCR method, band of investment method, and survey.

Need to convert the cap rate to a discount rate. I want to use the Y'sub'O = R'sub'O + CR formula. I am confusing myself and not sure that is correct. Actually, the result is not supporting my discount rate and I am not sure if I have selected the wrong discount rate or I am using the wrong formula.

Can anybody help me out here? Thanks in advance

 

[xm4yb7]

Cap rate + growth = discount rate

 

[Curtis West]

Cap rate + growth = discount rate

This formula works ONLY when both income and value are changing at the same compound rate. Where unit prices are stable, and expenses are increasing (causing a change in income levels), this is not the formula to use.

 

[Ken B]

Thanks guys (?),

built a model last night to check the results. Looks like I was a little liberal developing the cap rate. Since the CG likes the discount rate, guess I need to reconsider the cap rate.

 

[C. Kevin Bokoske MAI]

The cap rate is used for an income stream that is expected to continue indefinitely. That is not the case with a subdivision analysis; the income stream disappears when the last lot is sold. The use of direct cap has no application in your assignment, IMO.

 

[Fred]

This formula works ONLY when both income and value are changing at the same compound rate.

and where there is no leverage to create a difference between Ye and Yo.

 

[Ken B]

The cap rate is used for an income stream that is expected to continue indefinitely. That is not the case with a subdivision analysis; the income stream disappears when the last lot is sold. The use of direct cap has no application in your assignment, IMO.

Kevin, I understand your point. The function of developing the cap rate in this assignment is to convert it to a discount rate as supporting evidence of our discount rate selection. If you have a better alternative, I am all ears. (Eyes actually, I suppose)

 

[PropertyEconomics]

If it is only as a test of reasonableness why not just state so ... use the Overall Rate plus the Rate of Change (explained that its not academically correct because of the slight changes in expenses annually which are not offset by a change in income) ... compare that against market derived rates and analysis of competing investments .. and let it go at that.
Its just a test isnt it ...

 

[farmguy]

Curious, you said you have a discount rate. Where did you get it?

PE, could you explain what you mean above. Is rate of change appreciation or depreciation, or is it related to income?

I guess I don't see connection between OVR and discount rate.

 

[farmguy]

PE, never mind, I have found reference to what I was asking.