Question

Provide at least 3 different real estate valuation models. You need to include the discounted cash flow (DCF) model.

Answer 1

There are 3 approaches to value real estate:

1- Comparable sales approach

It is a relative valuation method. In this approach past transactions of comparable properties are identified and are used as benchmark to determine the value of the property. It involves the following steps :

(i) Identifying actual market transactions of comparable properties.

(ii) Finding price multiple for the properties based on some features of the property to derive the property’s value.

(iii) The multiples derived from comparable transactions are then multiplied with the same feature of the property to arrive at a value estimate

2- Income approach

It is a time value of money based method. This includes direct capitalization method and discounted cash flow method.

(i) Direct capitalization method - It values property as a perpetuity (an infinite cash flows)

value of property= Annual Net operating Income/ (cap rate - annual growth rate)

(ii) Discounted cash flow method- It evaluates present value of expected cash flows in future with the help of a discount rate (generally weighted average cost of capital)

DCF= CF₁/(1+r) + CF₂/(1+r)² + ........... + CF_n/(1+r)ⁿ

3- Cost approach

It values real estate at its replacement costs.