By Altus Group | October 13, 2020

Video: Understanding the Discount Rate in Commercial Property Valuation

ARGUS Training Manager – Americas, Jessica Leal, goes into detail about understanding the discount rate in commercial property valuation. This video will help you understand what a discount rate is and the factors that go into a discount rate. Watch the video or read the entire transcript below.

 

 

“Understanding the Discount Rate in Commercial Property Valuation,” Transcript

Hi, everyone. This is Jessica Leal the training manager for our Americas region. And today we’re going to talk about discount rates. So, in some of our prior articles in our prior videos, we talked about the DCF method evaluation and we did mention how discount rates play into that method.

What we didn’t talk about was what exactly a discount rate is. So, this video is a bit of a follow up to our insights articles Understanding the Discount Rate in Commercial Property Valuation. This article discusses what exactly a discount rate is, and it discusses some of the different factors that go in to choosing a discount rate. So, for instance, the higher the risk is for a particular property, the higher the return should be for the investors typically.

And so, this article discusses that. And what I want to do is really go into Argus Enterprise (AE) and see where we enter in our discount rate or our desired rate of return. And what that means for some of our different reports and what other tools are available in regards to those discount rates. So, let’s get into Argus Enterprise and see this in action.

Now once I get into Argus Enterprise, I already have a property open and in this property I already have all of the basics modeled I have the property name our analysis start our end date. I have our market data miscellaneous revenues operating and capital expenses and rent roll all modeled and the tab that I really want to focus on is our valuation tab, we have our investment tab where we’ve entered in our property purchase and any debt associated with the property.

Now our very last tab is our valuation parent tab and we’re going to come back and talk about some of these other sub tabs, but for now, we’re really going to focus on the present value sub tab because this is where we enter in our discount rate into Argus Enterprise. And so, if the desired rate of return that I want on this property is 15%, I can come right here to the discount rate and enter in 15% and once I enter in 15% I can also choose my discount method whether that’s monthly or quarterly semiannual or annually, which we’re going to use annual in this case, now not only can we enter in our primary discount period but in Argus Enterprise.

We also have the ability to enter in a secondary discount period. So for instance, if we need to know the present value as of our stabilization date we have the ability to do that as well and enter in a secondary discount period as of stabilization date. We can even go in and change the discount rate or we can keep it the same at the 15%.

We also have the ability to change the discount rate for our cash flow versus our resale on an unleveraged or leveraged basis. So if I wanted the leveraged discount rate to be a little bit higher I do have the ability to go and increment that as well and make that a little bit higher or I can keep it the same. Now that we’ve taken a look at some of the different items that we can do with our discount rate.

Let’s take a look at the reports that show the present value of this property. So if I navigate over to our reports the main reports that I want to take a look at our valuation reports and what I want to do is I want to navigate to the valuation reports parent tab present value sub tab. And when I get to that present value sub tab, I can see what our present value is based on our 15% discount rate.

Now this report also gives me our present value at other discount rates. So, you can see that we have .5% increments it goes from 14 to 14.5 to 15, and so on. So I can see what our present value is at 14%,14.5, and so on. If I want to change the increments right here on this report, I can actually navigate back into my inputs navigate to the assumptions sub tab below that valuation parent tab. And instead of a discount rate interval of 0.5 I can increase that to 1% and when I navigate back over to that report we can see now that it is showing us the present value at a 13% discount rate 14, 15, 16, and 17.

Now another thing that we did when we were in our inputs is we entered into a secondary discount period. Once again, if we wanted to see what the present volume is as of a stabilization date I can navigate to our ‘Present Value As Of’ report. And I can see what our present value is as of our stabilization date.The last report that I really want to mention that I think is pretty beneficial when it comes to discount rates is our ‘Value Matrix’ and our ‘Value Matrix’ is a great report because it’s going to give us an entire matrix worth of present values present values per square foot, as well as going in cap rates and you can see that we have a horizontal and our vertical axis and you can see the data that is across our horizontal axis is our it’s our net cell price and our exit cap rate itis labeled for you up there.

And then on our vertical axis, we can see our cash flow discount rate and our resale discount rate. If we were to enter into different ones we could see two different ones here. But I just kept it the same for this video. And so with this discount rate versus this exit cap rate and net sale price we can see what our unleveraged present value is. But the great thing about this report is we can see that if we changed our exit cap rate or if we changedour discount rate we can see how it will change the present value of the property.

And so I hope you enjoyed our video for today. 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 atthe end of this video.

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