Using DCF to arrive at a current value for office properties
Seems like the DCF methodology is more appropriate given some of the nuance of office (chunky TI and LC amounts below the line, potential large capital replacement reserves for back of the house, etc).
I have been reviewing several appraisals completed 2020-2022 (pre Fed tightening) which all used discount rates in the 8-10% range, a 10 year cash flow and then reversion pricing based on an exit cap in Year 10 anywhere from 7.5%-8.5%.
Assets were all large (500K+ square feet) CBD-type high rise office properties. Secondary market locations (i.e. Minneapolis, Cincinnati, Charlotte, etc).
Relative to where the market was then vs now (putting aside the muted interest from investors in this type of product), purely on an interest rate vs cap rate basis, I'd wager that 150-200bps should be the spread on top of whatever cap rates were used in an appraisal 2-3 years ago. Many appraisers use formula of 60-70% mortgage constant and 30-40% equity return to derive a cap rate, and by that math, the numbers are at a minimum 150-200 bps higher based on a higher debt constant and implied equity return.
Using a DCF, I am just curious where you all might peg the discount rate when looking at a 5-10 year cash flow model on CBD office assets.
Super logical. I like the approach!
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