What's the process you go through to determine a value for a property?

For people in acquisitions or appraisal, what process do you go through to determine a value for a property? 

Historically I've just gone with a quick cap rate and looked at a sale comp chart for trades and ball parked a value. I mean at the end of the day, the value of a property is how much people are willing to pay for it.

I've been getting some blowback from our analysts saying we need to be using a full blown discounted cash flow approach with exit cap rates and discount rates to get a value. I just don't see the need since it's garbage in garbage out. Anyone here think the "discounted cash flow" approach is the gold standard to value a property? How do you comp out discount rates and exit cap rates? 

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Comments (8)

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Apr 2, 2021 - 6:59pm

Using the direct cap approach is typically best for assets that are already stabilized and / or newer. What about properties that are not yet stabilized, have differences between in place rent and market rent or are old buildings? If you were to enter into a bidding processes for this type of asset, say multi-family, and it has 70%+ of the current units at substantially below market rents and you just applied a direct cap approach to that current NOI you would substantially undervalue and therefore underbid for the asset. Another bidder that modeled out the increase in NOI over the next 5-years with a DCF as tenants turn and uses an exit cap on a substantially higher NOI value, would escribe substantial more value and a "more accurate bid" than yours. Similar logic is you are valuing an old building that requires a material amount of go forward capex or if it's not currently stabilized. If you didn't account for this properly through a DCF you would not be able to gage an accurate valuation. 

Apr 2, 2021 - 7:57pm

Depends on what this is for and who you work for, how detailed you need to be, what questions you're going to be asked, etc.

I handle valuations for some of our properties and the valuations consultant we work with, Altus, generally has us do a direct cap and DCF, in terms of investment rates core areas in major metros are around 5.5% 5.75% going up to around 7% for tertiary product (this is multifamily FYI).

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Apr 2, 2021 - 8:19pm

How do you get the right exit cap rates and discount rates? When I'm talking to brokers or competitors, they always talk in cap rates, never in discounts / exit caps.

It's not like a direct cap or sales comp where you can generally be pretty confident where the market is. 

Apr 5, 2021 - 4:16pm

Exit cap is just an estimated spread over the going in cap, most people plug in something around 10 bps per year so that a 10 year hold will have a 1% higher exit cap.  The idea is that the property will have a higher cap rate as it ages, and its also just a buffer to make sure you don't overvalue the property if the market changes during the hold.

Discount rate is the acceptable rate of return for the risk profile of the deal (i.e. stabilized core assets will have lower discount rates) and the asset class in general.  You get a feel for where discount rates land for different deals as you underwrite a lot of them and get feedback from brokers and other owners on where the market is (i.e. broker might say you were outbid because a certain investor type was underwriting to a 6% instead of your 7%).

Theoretically the discount rate = the cap rate + NOI growth rate (so a 5% cap with 2% NOI growth has a 7% discount rate), but it rarely lines up perfectly in practice. 

Array
Apr 5, 2021 - 9:52pm

I'll add to this, at my super conservative Life Co lender, as Just a point of reference where this came from - I was always taught exit cap and discount rate will have a spread of 50-100 bps. Generally, your discount rate will be 50-100 bps above your exit cap. Though I've seen it be 25 which implies you're stretching to get to the value, as a lower discount rate implies a higher value. 

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Apr 2, 2021 - 9:19pm

You use a mixture of both. They should generally be near each other anyway. Cap and discount on a 10 year basis to get the value. And than verify it with a direct cap. If the property isn't stabilized, you're not going to cap the 'as-is'. You will cap the as-stabilized. However, your purchase price will be some factor below this as you need to leave profit margin for doing the work to stabilize the property. Generally, the most opportunistic deals will be valued based on 20% profit margins. So a development with a total development cost of $100 should be valued on exit around $120. 
 

In reference to the question above on how to figure out discount rates, some of it is feel and seeing enough flow. For instance, I could tell you most NYC core and core plus office deals in 2018-2019 traded at a 6% unlevered IRR over 10 years. Appraisers will also track discount rates and you can call them. I have found the brokerage teams do too - but only in the institutional space. I have found the middle market brokers usually don't look at discount rates. Also, when it comes to discount rates, always be mindful you should be looking at deals unlevered. 

Apr 5, 2021 - 3:16am

Depends on how detailed you wanna go.

For large institutional clients I normally do a DCF, using CoStar to get yield comps, decide on the entry cap rate and then do the some with the exit cap rate. Most cases it normally gets increased by 50bps or so though of course this changes by the specifics of the asset. Also pick a discount rate of course along with your growth and opex assumptions.

Sometimes I'll do Term & Reversion if it's for a client who just wants a quick valuation done. A lot of the time I actually find this results in fewer inaccurate valuations as it doesn't rely on a host of assumptions that can be unrealistic. The big boys don't like it though as they find it too simple.

I'll only ever use the direct cap rate if the property is rack rented.

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