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.
Income capitalization approach Sales comparison approach Cost approach
1) Back of the Envelope 2) SFFA - Front Door Approach 3) Discounted Cash Flow
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.
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.
Meant to throw silver banana. I see this all the time
that's what i first thought when i read this but it sparked a surprisingly interesting discussion
Valuing a property means determines the economic value of real estate. To determine fair market value, the price at which a knowledgeable seller willingly sells her property and a knowledgeable buyer will willingly purchase it.
How to calculate value (Originally Posted: 09/22/2016)
I have a assignment that is asking me to do a DCF and calculate the value of a office building.
The discount rate is 8.5% The exit cap rate is 6.5% The Sales costs are 3.0%
NOI on the last year is $4,027,746
How do I calculate the value?
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.
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.
Why is the 8,5% discount rate too high for an 6,5% exit cap rate? This simply suggests a 2% NOI growth rate in perpetuity.
If that is all the info he gave you and you know the building is stabilized I think the value is about $56 MM (assuming 5 year hold)..
depending on if you use years,quarters or months for compounding and add year 5 NOI to terminal value I have gotten numbers from 55.7mm to 58mm.
Hard to get the NPV(in excel) when you only get the last years cash flows and no time periods
Yep, agree with this using a 5 year hold and 3% NOI growth
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.
Not exactly, the 3% sales cost occurrs in the future, so you take 3% from the future value THEN discount back and get the PV
You subtract the 3% sales cost in the terminal year, not the PV or Year 0 year. IRRelevant is right on this. No such thing as a a single year hold for 99% of RE funds/companies. The assumption of 5-years is a good guess, most holds are between 5-10 years on a proforma basis.
iSince we don't know the hold period in this case I just used 5 years which is fairly common. 10 year DCF is also very common.
Calculation of NPV / valuation of residential property (Originally Posted: 03/18/2013)
Evening one and all.
I'm trying to use DCFs to calculate whether a residential property is theoretically a good project to pursue but I'm stuck. I can provide rough numbers if needed, but at the moment I am looking for an R and I'm not sure where or how to calculate it.
I see that R is the opportunity cost, ie what the market would otherwise return. For the initial capital, I am assuming to use the current value of the property (ie what it will sell for undeveloped) plus the cost of development. No debt is assumed.
So my stumbling block is: where can I get an R to use to discount? And are DCFs / NPV the best way to calculate this or should I look at something else?
Regards
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.
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.
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.
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.
Valuation of Property Project (Originally Posted: 07/03/2013)
Hey guys, I am a current summer analyst for an investment bank in Asia and for one of my project that my boss wants me to do as sort of a case study is a valuation of the financing of a property project located in Chicago. I am pretty familiar with building models but have not had the pleasure of learning to build a project finance model. I was given all the information regarding the project from Total Development cost to the Financial Measures summary sort if anyone wants me to PM them a pdf copy of this I can definitely do so. I honestly don't know where to start and really how to do a valuation of this project to see if it is a good investment or not and would honestly appreciate anyone that could help me.
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
I'm also new in RE area, hope some prof can come here and help us out.
PM me your dropbox email, I think can share with u sth that might be helpful.
How does your company/senior management evaluate property? (Originally Posted: 12/29/2017)
Hello Everyone,
I know there are multiple ways to look into a property and come up with an analysis depending on property type and strategy. But can we get everyone to list their property specialty and what metric/important indicators the company's senior management looks at when making a decision to buy a property/building etc?
For example, when you are making your pitch to your boss, what would catch her or his eye to seriously consider making the purchase?
yayaa, bummer your thread hasn't had a response yet. Maybe one of these threads could point you in the right direction:
Any pros willing to rescue this discussion? SilverBullet17 TT3 Haziyev
You're welcome.
I pitch my foolproof exit strategy first. No joke.
bump....
resi development. untrended stabilized NOI yield relative to projected exit cap.
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