Real Estate Valuation: Part 3 (Discounted Cash Flows)

This approach is called Discounted After-Tax Cash Flow Approach. This method is used as a supplement to the other valuation methods, such as cost, sales, and income approach.

Under this approach, the investor calculates the net present value of after-tax cash flows from the property discounted by his required rate of return. For the investment to be worthwhile, the NPV of cash flows should be positive. Alternatively, the IRR should be higher than the investor’s desired rate of return.

Numerical Example

An investor is considering purchase of a property now and selling it after a period of 5 years. The details of the property and its financing are provided below.

Property Purchase Details


Property Purchase Price		1000000
Equity	25%	250000
Required Cost of Equity	12%
Debt	75%	750000
Debt rate (p.a.)	8%
Interest is Tax-deductible	Yes
Straight Line Depreciation	5%	50000
Mortgage Payment		66621
Marginal tax rate	31%
Year 1 NOI	100000
NOI Growth Rate	10%

The property sale details are provided below:

Property Sale Details


Property sold after (Years)	5
Capital gains tax rate	20%
Sale Price (Forecasted)	1200000
Property Sale Expenses as a % of sale Price	5%

Result

Using the Discounted After-tax Cash Flow approach, the NPV of this project is positive ($78,098). Therefore, the investor should invest in this project.

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Real Estate Valuation: Part 3 (Discounted Cash Flows)

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