Valuing a property

Hi guys,

I just wanted to get a comprehensive answer on how to best go about valuing a property. I know that there have been other threads about this, but if someone could provide a single answer that contains all necessary components it would be greatly appreciated. More specifically, I am in the process of being interviewed and would like an answer that would suffice in this type of context.

 

I Googled SFFA and what came up was a presentation on using front door and back door SFFA to see if a loan is feasible (hence one of the F's). Truly not trying to split hairs here, trying to learn. Are you really using front door/ back door to value a property, or just to see if a loan amount makes sense? The answer to a front door approach is "required rent per foot" correct?

Of note, the appraiser on a single family home seems like he is doing both: giving a true "value" for the property and seeing if the loan makes sense based on that value.

 

In school I was taught to use the front door approach to give me the "rent required" but I like to find the required NOI (just subtract opex) and then the back door approach to give me a max price that I can pay for the property.. I guess to make things easier, you can think of the "Front Door" approach as looking at the property from an investors point of view and the "Back Door" approach from the lenders point of view. I hope that gave you some clarity on my response but to be honest I would focus on learning to look at a property without getting super granular. In my opinion, the BOE evaluation is the most important step in underwriting but a complete waste of time if you don't understand which key metrics to look for.

 

(Not universal) rules of thumb:

Multifamily heavily leans towards the direct income capitalization approach. Other CRE leans heavily towards the discounted cash flow approach (exception to this might be stabilized, Class A retail with long-term leases). Straight-up SF residential leans heavily towards the sales comparison approach. The context of your interview matters greatly.

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Best Response
CREguy:
Hi guys,

I just wanted to get a comprehensive answer on how to best go about valuing a property. I know that there have been other threads about this, but if someone could provide a single answer that contains all necessary components it would be greatly appreciated. More specifically, I am in the process of being interviewed and would like an answer that would suffice in this type of context.

There are literally entire books written on this. Read one of them.

WSO is not the place where other people do your homework for you.

Commercial Real Estate Developer
 

School assignment? Work assignment? Terminal value? Today's value? If today's value, how long are you holding it for? Is there any cash flow between now and when you sell it? If the terminal value, that's typically calculated based on the next year's NOI.

www.assessre.com
 

You are missing a lot of info to run a DCF (market rent, capex, market rent growth, occupancy, general vacancy, lease terms, etc.). Just looking though at your assumptions an 8.50% discount rate is way too high if you think the exit cap is 6.50%. Also, 3% is way too high. That is without knowing anything about the building just a general observation.

 

It grows by 2% and then you capitalize it by 6.5%. Once you get the present value, you assign a 3% sales cost discount.

“Elections are a futures market for stolen property”
 

Disclaimer: I know little to nothing about real estate or how real estate is valued.

But -- Say the initial investment for the property is 100k and you are paying cash. Your 'R' or required rate of return would be determined, in my opinion, by the return you could reasonably achieve if you invested that 100k somewhere else. So, theoretically, if you are going to either pay for the property in cash or invest the 100k in an S&P 500 ETF which you believe will return 8% than your required rate of return would be 8% plus any premium that you deem necessary.

Your discount rate is essentially the rate of return you require on the investment to make it worthwhile.

The net present value analysis will tell you (not in an absolute sense) whether or not the project is worthwhile by virtue of its positive or negative net present value at your required rate of return and initial investment.

[quote=patternfinder]Of course, I would just buy in scales. [/quote] See my WSO Blog | my AMA
 

Alright, I follow that. I calculated IRR to be 7-10% depending on the numbers I put in - I assume such returns would be difficult to find on the market? That is, safe enough returns.

When I run the calculation, do I put the value as a negative even though the property is already owned? ie - because the option is there to sell, I call it -ve because it's an opportunity cost?

And with the NPV, at what point would you say the project is worth following (theoretically)? I have figures from 3.84 - 27% of the projected final value, but I haven't a solid idea as to what this implies.

Offshore liffe
 

In a vacuum the project is worth following if it has a positive net present value.

In your situation I would simply discount the cash flows back to present day and if they are greater than the price you can sell the property for than do the project. If not, sell.

Example:

(20,000)/(1+ R)^1 + (20,000)/(1+R)^2 + ...

This scenario would assume there is no initial investment needed for the property to earn its cash flows.

Should there be an initial investment needed:

Just use excel's NPV formula. If it is positive than it is a viable option. If negative, not viable.

[quote=patternfinder]Of course, I would just buy in scales. [/quote] See my WSO Blog | my AMA
 

An NPV or an IRR analysis are essentially two sides of the same equation. In an NPV analysis, you provide all future cash flows and the discount rate, which allows you to arrive at value today. You compare present value with initial price, and provided value exceeds price (or in your case, present day opportunity cost), you do the deal. In an IRR analysis, you enter today's price (or opportunity cost, etc.) and the future cash flows, and solve for IRR. You compare IRR with discount rate, and if IRR exceeds discount rate, you similarly do the deal.

Which approach you choose depends a bit on the type of asset and the acquisition situation. NPV is particularly helpful when you are buying an asset with an indefinite holding period (for instance, if you are buying a business you may hold forever and for which you want to understand intrinsic value, or for a marketable security that you could sell at any time and are hoping to profit on a convergence of price and value). NPV is also helpful when an asset is unpriced, and you need to figure out value to get to a price.

In real estate, the price to buy a property (or the price at which you could sell it) is often known. There is also, as in your case, a realistic business plan with cash flow timing and exit timing. As a result, IRR is generally the more instructive analysis. The root of your question is really, once you have the prospective IRR, what does it mean and what is enough?

Here are some tips: it's not going to be easy or useful to arrive at an appropriate discount rate using traditional corporate finance tools (the concept of beta is not really applicable). Instead, I would carefully consider the risk profile of your deal and compare it to other investment opportunities. It sounds like in your case there is some development risk. Is there entitlement risk? Are you or people you trust skilled enough in development that you can be highly confident in the cost component of your cash flows? How long will you have to wait before you can sell and earn the reversion cash flow that justifies you project? The longer you have to wait, the greater your market risk. Where is the real estate? Are you in a supply-constrained market with solid demand drivers? Lots to consider. In terms of benchmarks and comparisons, what are the expected returns to buying a homebuilder's stock? What about REITs? REITs are buying core real estate in the best markets at ~5% cap rates. If we assume there is also value appreciation in those markets, they are maybe solving to ~7-8% unlevered IRRs. Based on that fact, I would probably suggest that a 7-10% IRR on a development deal you have to execute yourself is not a good investment, but I know virtually nothing about your project.

 
Tianying He:

I really think maybe we can work it out together.

I still need help on it and any help would be more than appreciated. how do you propose on doing so

 

yayaa, bummer your thread hasn't had a response yet. Maybe one of these threads could point you in the right direction:

  • Can a Hedge Fund Manager Live at an Investment Property? If a hedge fund decides to invest in luxury real estate, is the hedge fund manager allowed to use ... and the property could be rented out in between the time it is purchased and sold, but if the house ... sells for more than the purchase price and/or the fund outperformed the market, I don't see how ...
  • a question about terminal growth rate, discount rate and property evaluation You are considering purchasing a property with a 5 year holding period. The sum of your discounted ... rate is 7%. How much should you be willing to pay for this property (to the nearest cent). Can anyone ... and the anticipated cash flow in year 6 is $175,000. Your terminal growth rate is 2% and your discount ...
  • Profile evaluation: 760 GMAT + crap GPA Hi all, Here's my profile for your consideration: PERSONAL Male, 30 years, Australian of East ... a local university (ranked in the 200s by Topuniversities Dot Com) Terrible GPA- not sure how it converts ... Manager for Whole-of-Government e-commerce solutions. Government career has had two interruptions, listed ...
  • Evaluating a Real Estate Investment agents, when purchasing a property how does the commission work for the listing agent if I'm sourcing ... estate loans and properties, how does that process differ from residential? What kind of down payment ... included in operating expenses assuming I would not use a property manager (have read quite a few posts ...
  • Evaluating Commercial Banks- Earnings (part 2) / M&A?-What's driving NIM / does it make sense with their asset / liab mix?-How is non-int income doing / is it ... the provision involved asset quality evaluation)-How's efficiency / expenses?-What's ... management's strategy if any of this isn't going so well?-How are the ultimate returns / are they meeting ...
  • Comp Season... things to remember get over your comp. It's amazing to me how pissed people will get if they are 5k below someone ... initially. If you're at an asset manager, here are 8 questions to be asking when evaluating your ... arbitrary your ranking and comp is when you're starting out. The number is not what matters, at least ...
  • 2017 Hedge Fund Report: 8 Key Takeaways a potential proxy for reputation. Data up until November 2017. Senior Management Key Observation 6: Top senior ... management rankings align with other categories except top average compensation. The senior management ... Shaw The data suggests a strong correlation between opinions about senior management and the ...
  • More suggestions...

Any pros willing to rescue this discussion? SilverBullet17 TT3 Haziyev

You're welcome.

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