Present Value Factor?

[Rhombar]

To get the present value, you not only have to have a present value for the income stream, but also the present value of the property reversion at the end of the income stream.

The D in DCF stands for discount. It implies that future dollars are worth less than current dollars. The difference is the rate. If you could invest a dollar for 10% per year, a dollar today would be worth $1.10 in a year, so a dollar in a year would be worth 1/$1.10 or $0.909091 today. This is the annual discount rate for 10%. A dollar the second year would be worth $1.00 x .909090 x .909090. Each year the discount factor is taken to a power equal to the year, 3rd year - power of three, etc. The income in the 10th year has a present worth of .385543%. Similarly, the value of the property reversion in the tenth year is reduced to the same percentage. All of the discounted income and reversion are totaled to determine the net present value.

The actual discount rate will be dependent on the risk associated with the income stream. Try finding some capitalization rates for similar properties or properties you deem to have similar risk and try using a similar rate.

 

[PL1957]

The actual discount rate will be dependent on the risk associated with the income stream. Try finding some capitalization rates for similar properties or properties you deem to have similar risk and try using a similar rate.

Although a cap rate can give you a starting point, don't confuse it with the discount rate. Traditionally, a discount rate has been equal to a cap rate plus the compound annual rate of change for the income stream over the holding period, assuming a constant rate of change. You can't simply take a cap rate and use it to discount cash flows.

 

[Rhombar]

Although a cap rate can give you a starting point, don't confuse it with the discount rate. Traditionally, a discount rate has been equal to a cap rate plus the compound annual rate of change for the income stream over the holding period, assuming a constant rate of change. You can't simply take a cap rate and use it to discount cash flows.

I didn't mean to imply they were the same, just that the cap rate is a good place to start as you develop your discount rate. If the income stream is the market income stream and if the value at reversion is the same as the capitalized market income value, discounting the income and the reversion at the same rate as the cap rate yields the same value as capitalizing the market income stream. Because the actual income stream is seldom the same as the market income stream adjustments need to be made for the differences. The differences between the actual and market income for each year can be reduced to a net present difference that can then be applied to the market income value, this should equal the DCF value. You can then back into a discount rate by adjusting the cap rate until the market income stream yields the same number. Then apply that discount rate to the actual income and reversion.

 

[PropertyEconomics]

I didn't mean to imply they were the same, just that the cap rate is a good place to start as you develop your discount rate. If the income stream is the market income stream and if the value at reversion is the same as the capitalized market income value, discounting the income and the reversion at the same rate as the cap rate yields the same value as capitalizing the market income stream. Because the actual income stream is seldom the same as the market income stream adjustments need to be made for the differences. The differences between the actual and market income for each year can be reduced to a net present difference that can then be applied to the market income value, this should equal the DCF value. You can then back into a discount rate by adjusting the cap rate until the market income stream yields the same number. Then apply that discount rate to the actual income and reversion.

A bit of a self serving process if you ask me.

 

[Rhombar]

A bit of a self serving process if you ask me.

Not so! If the DC and DCF are supposed to equal the same thing +/- leasehold or leased fee interest, then you have two equalities and are merely solving for the other side of the equation. We do this all the time when we apply adjustments we've found using one approach to another.

 

[PropertyEconomics]

If they are not independent .. one cannot be used as a check agaisnt the other .. and tests of reasonableness should be considered in all methods of valuation. IF there is a stark difference, it leads you to look harder at what may be in correct or something that may have been missed .... when you back into a rate by using a benchmark of value based on another rate .. the tests are no longer present.

 

[Rhombar]

If they are not independent .. one cannot be used as a check agaisnt the other .. and tests of reasonableness should be considered in all methods of valuation. IF there is a stark difference, it leads you to look harder at what may be in correct or something that may have been missed .... when you back into a rate by using a benchmark of value based on another rate .. the tests are no longer present.

That's why I suggested starting with the cap rate. If the DC and DCF don't yield similar results you know you have something that hasn't been accounted for. Once you have determined what differences need to be accounted for, you assume the market will recognize those differences and compensate for them. The math I suggested reflects those market perceptions. Now if one is not compentent to analyze the market and reflect it in their calculations then they are probably not competent for the assignment.

 

[PropertyEconomics]

That's why I suggested starting with the cap rate. If the DC and DCF don't yield similar results you know you have something that hasn't been accounted for. Once you have determined what differences need to be accounted for, you assume the market will recognize those differences and compensate for them. The math I suggested reflects those market perceptions. Now if one is not compentent to analyze the market and reflect it in their calculations then they are probably not competent for the assignment.

The discount rate and the overall cap rate are typically not the same ... atleast in the analysis I have done. At the very least the discount rate is the overall rate plus the rate of change (both increases and decreases in income as well as increases / decreases in expenses) in the overall income.

 

[Rhombar]

The discount rate and the overall cap rate are typically not the same ... atleast in the analysis I have done. At the very least the discount rate is the overall rate plus the rate of change (both increases and decreases in income as well as increases / decreases in expenses) in the overall income.

With all due respect, and I mean that, from where do you obtain your discount rates? Do you extract them from income and expense analysis of sales, or construct them from band of investment analysis? I humbly request an education.

 

[Michigan CG]

Welcome to the forum Rhombar. It is a great place to debate cap rates on a Saturday afternoon.