Video: How the Time Value of Money Applies to Commercial Real Estate Valuation
ARGUS Training Manager – Americas, Jessica Leal, shares her insight about the basic concepts of the time value of money, and then she will walk through how this is modeled in ARGUS Enterprise. Watch the video and read the entire transcript below.
“Time Value of Money ,” Transcript
Hello, my name is Jessica Leal, and I’m the Training Manager for our America’s region, and today we’re going to talk about the time value of money, in ARGUS Enterprise. Now, this video is serving as a bit of a follow up to our insights article, How The Time Value of Money Applies to Commercial Real Estate Valuation.
And this article is a great article because it talks about the basic concepts of the time value of money. It also talks about compounding and discounting. And, when we get to the discounting section, this is really what we’re going to focus on in ARGUS Enterprise, because if we see a series of cash flows, such as we see in the article over a certain holding period, this is discussing how your rate of return can affect what you have to pay today in order to achieve that rate of return or discount rate.
And so, what we’re going to see now is we’re going to get an ARGUS Enterprise and see where we enter in these discount rates and take a look at some of the reports that show our present value today. So, let’s go ahead and get into (AE). Now once I get in ARGUS Enterprise, I currently already have a property open. And the first step in determining what the present value is of your property is going to be generating those cash flows for this property. And so, we get to choose when we want our analysis to start, how long our holding period is, or the length of our analysis, and in order to generate those cash flows, there’s a series of different pieces of data that we can go in and model, for instance, our inflation rates and our market assumptions, our revenues, our expenses, whether they’re operating or capital. We can model our tenant information; the area that they’re taking up, the rent that they’re going to be paying, as well as their reimbursements. And all of this information generates our cash flow, which we can actually find in our property reports parent tab, cash flow sub-tab. So we can see our cash flow for every year of our analysis. Now, once we have our cash flow, we can apply a discount rate to our property to generate a present value.
And so, the way that we do that is we actually go, we navigate to that valuation parent tab, present value sub-tab. And so if we require, as an investor, a 12% return on this potential investment, we can now enter in that 12% discount rate and go and take a look at our present value report to see the price that we should pay for this investment. So let’s take a look at that report. If I hit F3, I’ll navigate right back on over into our reports. And I can go to our valuation reports parent tab, present value sub-tab. Now, once I’m in our present value sub-tab, I can actually see the 12% discount rate that I’ve entered in. And if you take a look directly in the middle of this report, we can see our present value. So, if we require a 12% return, we would need to purchase this property for this amount or less. And we can actually see how this number changes if we change our discount rate. So let’s say that we needed a 10% return, if I change that to 10%, if you take a look at the present value will increase, because now that we need less of a return, well, we can purchase the property for a higher price. Now, this report is great because it doesn’t only show you your present value at the discount rate that you enter in, it also shows you the present value at a range of discount rates. So, we can see what the present value would be, a 9.5. 9.75, 10.25, and 10.5 as well.
Another report that will show us our present value is going to be our value matrix. This report is great because it gives us an entire matrix of present values. Now, the horizontal axis is going to show us our net sale price and our exit cap rate, based on what we’ve modeled in this property. Our vertical axis is going to show us our discount rate directly in the middle. But then, of course, we’ll see that range of discount rates as well. So the 9.5, 9.75, and so on. And if you take a look directly in the middle of our value matrix, we will see the same present value we saw in our present value report. However, it is giving us a range of discount rates. So, if our exit cap rate was 7% and our discount rate was 9.5%, we can see the present value with those variables. So, this is giving us a whole range of present values that we can see. Now that is actually it for our insights video, remember if you have any questions, you can always reach out to us.