DCF

NPV

1) CFs – inflow (1) Rental i) Contracted ii) uncontracted 2) Reversion CFs => ascending riskiness
but we used to not discount them at different rate when they should) & outflow
2) RRoR- WACC(ROA)/Ke (ROE)
3) PV at RRoR

IRR

IRR => Ingoing (AKA in-going yield/going-in IRR: calculated by buyer based on prPrice given. Defined
as expected average multi-period return (per period)) vs Outgoing (how others will be buying my
property?)

Bundling of property CFs by i) period & ii) Risk

i) Period: CFs within each year of holding period is bundled together at discount by
assuming CF received at end/start of the period
ii) Risk: we discount all CFs within the year and over holding period by a single RRoR.
 Not appropriate but practical.
 Are we OVERVALUING or UNDERVALUING?

=>Risk part can be adjusted to reflect higher risk of certain CFs particularly -> Reversion CFs and
Uncontracted rents (HOW MUCH Risk Premium to be added?)

Ratio valuation

1) Direct Capitalisation: current (upcoming year) NOI/current market cap rate

Most appropriate for buildings with short-term leases in less cyclical markets, e.g. apartments

Ingoing cap rate: Yr1 NOI/Price0 vs Outgoing cap rate: Yrn+1 NOI/Pricen (n=holding period)

In>Out: Price growth > NOI growth, over n

In<Out: Price G < NOI g, over n.

 Empirical cap rates are a way of quoting observed market prices for property assets (just like
PE ratios/Yield on bonds)
 Out going usually should be at least in going because older properties are more risky.
2) Gross Income Multiplier (GIM): V / Gross Revenue

Used for small apartment (commonly): may not reliably reveal good expense records (NOI
calculation impossible but rent can be observed in rental market)

Problem with two market-based ratio valuation

i) Differences in Characteristics: CFs growth and risk pattern different compared to typical
properties ?
ii) Rear mirror: Bubbles market price is used to price ur property => YOU WONT BE
PROTECTED!
Leveraging Returns:
Common mistakes => Too high CF too & Too high DR.

NPV => Maximise NPV for mutually exclusive projects 2) never do -NPV things

Zero NPV deals => If RRoR includes the risk premium, 0 not equal to zero profit, they just lack of
super normal profit. Thus, they are ok and acceptable for investment. If there are no other positive
NPV project, it must be taken according to the wealth maximisation principle because, otherwise,
you are leaving money on the table

Mortgage-equity Capitalisation

1) Obtaining value potential by limiting fin leverage: DCR (DCR is the prime factor behind
determining capital structures); moreover, we decide LVR based on DCR (how many times
our income can cover the debt servicing costs?
2) Identify sources of return: income and capital growth(reversion of CF)

Figuring out PV of all returns (equity) => Income return/equity vs reversion(incld. Cap
growth)/equity

i.e. Using their respective PV divide by total PV

***Reversion = Net selling price – loan balance repayment – CGT

IRR partitioning:

1) NOI (using beginning NOI as base)

2) Change in NOI over holding period
3) Original value
4) Net appreciation of value
 E.g. same IRR but what drives the IRR? => choose depending on preference
 Loan driven returns are ignored

i.e. Using their respective PV divide by total PV [total pv = sum of their PV]

Sale price => Largest cash inflows and most uncertain

This model: given forecast for all other valuation factors, the sale price which would enable us to
achieve to (after tax) RRoR/target return can be calculated

 We can calculate annual growth rate of property and check the reasonableness of such
growth

Other Factors influencing

i) Depreciation
ii) Stamp duty
iii) Income tax and CGT
iv) Capital structure
v) Selling Cost

Things to consider in the model

 Stamp duty in loan or in equity at 0.

 Available for CGT discount?
 CFo => LVR applied to prPrice or AC? (for AC stamp duty is also excluded from the equation
since Loan is already included in either loan/equity.)

Anything relevant to LVR, WACC, Ke and Kd

Leverage Ratio => Asset/Equity = V/E = V/V-D = 1/1-LVR

LVR = D/V

Debt coverage ratio => NOI/financing cost