I was tasked with finding a defendable discount rate to run an NPV analysis on a portfolio of single family units. Does anyone know of publication or paper or something that says an 8% discount rate is an industry standard?
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Discount at your target unlevered IRR
I haven't heard a number that is industry standard. Most places have their own assumptions. A PE shop I worked for used an 10-11% IRR for their assumptions.
Your discount rate should be the cap rate for the property + the growth rate of say that property type in that market.
This article simply lays out the relationship if you would like to read more.
https://www.google.com/amp/s/www.globest.com/2019/08/08/the-cap-rate-an…
A safe call is usually cap rate + 200-300bps, usually pretty defendable
Good luck, I don’t think you’re going to find a defendable source that says which method to subscribe to.
We use exit cap rate plus 200bps
Hey guys saw some comments saying discount rate should be unlevered IRR. Interviewing at few major funds and in terms of interview prep how would that be defensible? Say it's and 11% unlevered IRR, isn't discount correlated to cap rate and growth? So how would that make sense if cap rate was a 5% cap rate and growth 3% a year. Anyone have anything in general to dig deeper into understanding discount rates and having a solid argument to back it up?
Your target unlevered IRR. AKA your required rate of return.
Most firms just use target unlevered IRR to get a maximum purchase price they can pay while still hitting required underwriting metrics, then adjust pricing based on judgement from there (i.e. how bad do they want the deal, how much competition is there expected to be, do they have strong points to compete on aside from price, etc.). Another practice is a simple cap rate plus a few hundred bps.
Don't overcomplicate it. Young guys get too caught up in the technical side of the numbers when the market and real estate itself are way more important.
Thanks - great response. So the reason I’m over complicating it is because I’m interviewing for a top fund and I want to make sure I have deal explanation down and a why for assumptions/decent responses for other questions about assumptions used if asked.
Call multiple brokers. Ask what the 10 year discount rate is (unlevered). AKA what discount are buyers underwriting to on a 10 year deal without leverage. Also call appraisers. Now you will have data and a defensible discount rate.
While I’m not sure if you’re in the “institutional world”, but appraisers and brokers who serve the large institutions track this data.
PWC has periodic surveys that they publish.
It should be 4%-7% usually. I know for NYC office right now DR is 6.5% for like 10-15 year holds. It should necessarily be your unlevered IRR, since it is cost of capital. You may find a great deal, and still use the same discout rate. IF you have a deal where you have a 16% unlevered IRR, you are not going to use 16% as your discount rate.
I think you have to pay/subscribe for those, but Newmark has a free investor survey they publish which includes discount rates for each metro/asset type
Hang on - genuine curiosity here, but people are modelling 6.5% discount rates for NYC office right now?
6.25%-6.5%, yes. For trophy office buildings.
Are these stabilized? Value add? Should just be your targeted return given the risk profile
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