![]() First of all, there may be very few or no comparable transactions in the vicinity of the property considered. However, there are two problems in applying such an approach. Discount Rate Formulaįor an objective estimate of the investment value of a property the discount rate that should be applied to its cash flows should be estimated on the basis of the discount rates that were applied to the cash flows of comparable properties that were recently transacted within the vicinity of the property considered. Hence, during those times, required returns by investors and, therefore, real estate discount rates are lower resulting in higher property valuations from an investment point of view. On the contrary, when the economy is growing and the real estate market is strong with rising rents and falling vacancy rates, investors will consider property investments less risky and they will be willing to accept lower returns when acquiring real estate assets. This is a purely mathematical relationship, since the present value of any given cash flow decreases when a higher discount rate is used to calculate it. ![]() As a result, the investment value of real estate assets decreases considerably assuming that all other factors that affect property values remain constant. For example, when the market environment becomes very uncertain, as is the case now with the global coronavirus crisis, required returns by investors and therefore real estate discount rates increase considerably. It is important to understand the relationship between the prevailing market discount rates for real estate and the value of a property to an investor. Relationship between Real Estate Discount Rate and the Investment Value of a Property ![]() In addition to the above factors, the discount rate applied to the cash flows of a particular property may differ across investors because different risk tolerance levels and other reasons related to the situation of each investor may dictate different required returns and, therefore, different discount rates. The risk of the future cash flows of a particular property is determined not only by the state of the real estate market of the urban area within which a property is located but also by the specific physical, financial, legal and other characteristics of the property, as well the strength of its location and the state of the submarket within which it competes for buyers or tenants. The reason for these differences is that the discount rate is determined to a great extent by the risk of the future cash flows of any given property. Real estate discount rates differ not only across property types and urban markets but also across specific properties within the same property type and within the same metropolitan area. Difference between the Cap Rate and the Discount Rateĭifference between IRR and the Discount Rateĭiscount Rate, IRR and NPV in Evaluat ing Property InvestmentsĪpartment Cap Rates: Why are they Lower than Office Cap Rates?Ĭap Rate Formula: Read this Before you Use it ![]()
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