FINC 475 DCF CAP RATE (Due 9/16)

For a income generating property, you can find the value simply by dividing the net operating income by the cap rate. The cap rate is found by comparing similar properties. Another option is the discounted cash flow method.

The discounted cash flow method is much more complex than the direct capitalization rate for valuing real estate. This article explains the differences in detail. For one, under the DCF method you must calculate future NOI for each property and the reversion value in the calculation. Under the direct cap method, you only need the NOI and the capitalization rate, found by comparing similar properties. This results in a problem, because  NOI's are based on an appraiser's estimates based on market conditions. The appraiser must consider vacancy and collection loss. Under the DCF method, vacancy and collection loss are written off as expenses. For the most part, when the real estate is anticipated to be stable you should use the direct capitalization method, but in a volatile environment the DCF method should be used because it uses NOI's for each future year. Doing a DCF analysis is more extensive and provides more insight in the property. Thus, the DCF method is considered an "art" because the appraiser must take into consideration so many variables that must be based on his/her estimates.

In this article an esteemed professional in the real estate world claims that the discounted cash flow method will replace the direct capitalization method. He claims that the DCF method reveals more quality information and valuation. He also claims that the DCF method is more responsive to change.

This article shows the negatives of the direct capitalization method, claiming that it results in valuations that are too low. It claims that appraisers are having a hard time finding comparable properties to determine the CAP rate because there are so few sales. The article claims that the direct capitalization method does not respond to changes in the market, and it does not account for market cycles in the appraisal process.