Market valuation based on discounted cash flow analysis consistency in assumptions
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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

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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


Market valuation based on discounted cash flow analysis consistency in assumptions

Office rents in Stockholm CBD


Market valuation based on discounted cash flow analysis consistency in assumptions

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


Market valuation based on discounted cash flow analysis consistency in assumptions

Assumed operations and maintenace costs

in relation (%) to actual outcome


Market valuation based on discounted cash flow analysis consistency in assumptions

NOI year 2007


Market valuation based on discounted cash flow analysis consistency in assumptions

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) %


Market valuation based on discounted cash flow analysis consistency in assumptions

Implicit vs explicit yields


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

  • ”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

  • 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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