Video: The DCF Approach to Real Estate Valuation
Video: The DCF Approach to Real Estate Valuation
ARGUS Training Manager – Americas, Jessica Leal, goes into detail about the DCF approach to the valuation method in real estate and then will walk through how these variables are modeled in ARGUS Enterprise. Watch the video or read the entire transcript below.
« DCF Approach to Valuation, » Transcript
My name is Jessica Leal and I’m the training manager over our America’s region. And today we’re going to talk about the discounted cash flow method valuation. We’re going to talk about the concept of it and all of the different variables that play into this method valuation. And then we’re actually going to move to ARGUS Enterprise (AE) and see where these variables are modeled and actually see the DCF method valuation come into play within the program.
Now, this video is actually a bit of a follow up to our Discounted Cash Flow in Real Estate, insights article. If you haven’t had a chance to read that article yet, you can actually navigate to that article on our website by clicking the link that’s popping up right now. Now, this article covers a few different things, it talks about some of the major components of the DCF model, as well as the benefits and the advantages of using the DCF method valuation. There are other methods that we technically could use; we have our income capitalization approach, we can use sales comps to compare our property to similar properties in the same area to determine a value of the property.
However, those methods are not as complex or robust as a DCF model because the DCF method valuation has a lot of variables that go into it, such as the property’s operating performance, the market conditions such as inflation rates, rental rates, investment, and financing information as well as the property resale, and all of these different variables come into play when calculating the value of a property. And another advantage of the DCF approach is that it not only can calculate the net present value of a property, but it also can determine the IRR. So, this is one valuation method that provides multiple return metrics. So now that we’ve talked about some of the components that go into the DCF model, let’s move into ARGUS Enterprise and let’s see where we would model those components and let’s see how AE calculates our present value using our DCF method.
And so now I’m currently in ARGUS Enterprise and I have a property open and what I wanted to show you is all of the different inputs that go into our DCF model. Now, that can be considered really one of the disadvantages of this method evaluation is the abundance of inputs that go into this model. However, that’s also one of the greatest strengths because that’s what makes it so robust, that’s what makes it accurate. And so, the outputs and the metrics that we want from the discounted cash flow method valuation; those metrics are only going to be as accurate as the inputs that we put into this model.
And so, in ARGUS Enterprise we have a set of seven different parent tabs that we can navigate to and model our different input data. And so, it starts with the property parent tab and this is where we can model some of the basics of our property. When do we want our calculations to begin, so that’s our analysis begin date. How long do we plan on holding onto this property so we can enter the length of our analysis. We can enter in the area or property type in the name, we then have market data. So here this is actually where we can model our inflation rates, our growth rates, any general vacancy that we want to predict. This is where we can model all of our market conditions as well as our market leasing information and our market rental rates. We then have the ability to model miscellaneous revenues, operating expenses, lease information in our tenants’ parent tab, rent rolls sub tab and then we have our investment information where we can model the property purchase price. We can model any debt associated with this property.
And then we have our valuation tab. In our valuation parent tab we have different assumptions that we can apply if we want to run a little bit of sensitivity or risk analysis. We have our direct capitalization tab; this is where we can actually model our direct cap rate if we wanted to use that income capitalization approach.
The next tab is our property resale where we could go in and model our resale calculation for this property.
And then finally we have our present value. Our present value tab is where we can enter in our discount rate. And this is the discount rate that ARGUS Enterprise is going to utilize when calculating our present value and using that discounted cash flow method valuation.
So now that we have really seen all of the different inputs that go into Argus Enterprise and go into that DCF model, let’s take a look at some of the outputs. So that is a huge benefit of using ARGUS Enterprise is that, yes there are a lot of inputs that go into a DCF model however, this is a set template that you just go in and enter those inputs into and all of the calculations are embedded into the solution. And so, when we go and run our reports, we’re not also entering in any formulas. That’s already embedded into the program. So now what we can do is take a look at the outputs without having to worry about entering in any formulas.
So, I’m going to go ahead and I’m going to navigate right on over into my reports. Once I navigate my reports, we have a very similar setup where you have a set of parent tabs as well as sub tabs and these parent tabs all contain different reports. So dashboards, summaries, property reports – where you will find the property cash flow, and then we have our valuation reports. And for valuation reports we can get IRR metrics because we’re using the DCF method valuation and we can also get the present value of this property.
Now, once from that present value sub tab we can actually see what our present value is at that discount rate that we’ve entered in. So, our discounted cash flow method evaluation is being used here to determine our own leverage present value. So we can see that right here, we can see it’s taking into consideration our cash flow for every year of our holding period, it’s also taking into consideration our property resale. And so, a lot of variables go into this method valuation, which is one of the greatest advantages of using it.
That is actually it for our video today. I hope you enjoyed it and if you’re interested in any additional training or instruction on navigating through the program, questions about valuation methodologies or calculations, feel free to check out some of our different training options by clicking the link at the end of this video.