Property investment value, is the present value of a property to an investor, given his/her particular return requirements and
sensitivities,as well as the expected income stream from the property over the investment horizon.
An investor considering a property for acquisition can use different measures to assess its value from an investment point of view. The most commonly used model is the
, which takes into account all revenues and expenses associated with holding operating and disposing the property over the investment horizon.
The DCF model can be used to estimate the Present Value (PV) of the income stream expected to be received from the property over the investor's holding period using as
discount rate the investor’s required annual rate of return. The estimated present value represents the value of the property to the particular investor at the time of analysis, in the sense that this is the value the investor would be willing to pay to acquire the property in order to achieve his/her required rate of return. In this case the discounted cash flow analysis should ignore investment costs.
How to Use Investment Value
The real estate investment decision rule is the following:
If IV ≥ IC ====> Invest
If IV < IC ====> Do not Invest
where IV = Property Investment Value
IC = Investment Cost
If the property investment value is greater than property investment cost, it means that the property, based on the assumptions used in the discounted cash flow model, will attain an internal rate of return higher than the one required by the investor. On the contrary, if the investment value is smaller than the investment cost, it means that the annual return that the property will produce over the holding period will be smaller than the one required by the property investor.
The investment cost includes property purchase costs and other acquisition or pre-acquisition costs, such as notary fees, legal expenses, and other expenses associated with all due diligence that needs to be carried out before finalizing the transaction.
Property IRR versus Investor Required IRR
In estimating the present value of a property using the
DCF model, the investor needs to take also into account the expected
market value of the property at the last year of the holding period, in order to incorporate in the calculation any anticipated capital gains or losses. This reversion or resale value is usually estimated by dividing the expected
net operating income (NOI) of the property during the last year of the holding period by the
capitalization rate expected to prevail in the market during that year.
