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MARKET VALUATION BASED ON DISCOUNTED CASH FLOW ANALYSIS - CONSISTENCY IN ASSUMPTIONS. Stellan Lundström Royal Institute of Technology Christina Gustafsson IPD Norden. Background. 1997 Establishment of the Swedish Property Index in co-operation with IPD

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Market valuation based on discounted cash flow analysis consistency in assumptions

MARKET VALUATION BASED ON DISCOUNTED CASH FLOW ANALYSIS- CONSISTENCY IN ASSUMPTIONS

Stellan Lundström

Royal Institute of Technology

Christina Gustafsson

IPD Norden


Background
Background

  • 1997 Establishment of the Swedish Property Index in co-operation with IPD

  • A quality control process for index valuations

  • An ambition that assumptions should be consistent


Data source
Data source

  • 1997 – 2008: 24 000 Valuations

    • 83 % with DCF technique

    • All DCF assumptions and results are in a database


Main initial observation
Main initial observation

  • Valuation accuracy tested to be on a good level.

  • Feed back on DCF parameters raises question about the relevance in assumptions about discount rates, exit yields, rents, vacancies, operations and maintenance


Research questions
Research questions

Main question

”How are DCF assumptions related to each other

Specific question

”What is the meaning of DCF yields and discount rates when DCF is used for market valuations”


The swedish leases short and gross
The Swedish Leases– short and gross

Operation & maintenance

cost as % of gross rent

Source: IPD Multi National Index Spreadsheet 2008



Initial and long term vacancy rate in valuations

Office Stockholm CBD, 1st January 1998 - 2008

= Assumptions in valuations long term

= Actual outcome = initial vacancy rate


Assumed operations and maintenace costs

in relation (%) to actual outcome



Valuation of Office properties in Stockholm CBD 2004

- Discount rates and exit yields

10

9.5

9

8.5

Discount rate, %

8

7.5

7

6.5

6

5.5

6

6.5

7

7.5

8

Valuation yield (exit yield) %



Average values for input variables in the valuations 1997 2007
Average values for input variables in the valuations 1997-2007

NOI

n

0

time

8.7 – 3.3 = 5.3 < 6.9


Conclusions
Conclusions 1997-2007

  • ”All assumptions are biased – the result is OK!”

  • The same discussion as 30 – 40 years ago

  • Swedish valuers has developed;

    • An industry standard for valuation

    • A market monitoring system


Implications
Implications 1997-2007

  • Valuers - legitimacy

  • Investors – Interpretation of and need for decision support

  • Auditors– new role due to IFRS

    • Opinion about

      • Market value (fair value)

      • Assumptions behind market value

  • To value ”green buildings” there is a need for more explicit assumptions about NOI


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