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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. 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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  1. MARKET VALUATION BASED ON DISCOUNTED CASH FLOW ANALYSIS- CONSISTENCY IN ASSUMPTIONS Stellan Lundström Royal Institute of Technology Christina Gustafsson IPD Norden

  2. 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

  3. Data source • 1997 – 2008: 24 000 Valuations • 83 % with DCF technique • All DCF assumptions and results are in a database

  4. 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

  5. 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”

  6. The Swedish Leases– short and gross Operation & maintenance cost as % of gross rent Source: IPD Multi National Index Spreadsheet 2008

  7. Office rents in Stockholm CBD

  8. 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

  9. Assumed operations and maintenace costs in relation (%) to actual outcome

  10. NOI year 2007

  11. 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) %

  12. Implicit vs explicit yields

  13. Average values for input variables in the valuations 1997-2007 NOI n 0 time 8.7 – 3.3 = 5.3 < 6.9

  14. 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

  15. 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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