What's your process for estimating commercial property value with DCF analysis?

1 Gather data

The first step in DCF analysis is to gather relevant data about the property and the market. This includes information such as the current rent, occupancy rate, lease terms, operating expenses, capital expenditures, market rent growth, vacancy rate, inflation rate, and comparable sales. You will also need to estimate the holding period, which is the expected time that you or a potential buyer will own the property, and the terminal value, which is the estimated value of the property at the end of the holding period.

2 Project cash flows

The next step is to project the future cash flows that the property will generate over the holding period. This involves calculating the net operating income (NOI), which is the difference between the rental income and the operating expenses, for each year. You will also need to account for any changes in rent, occupancy, expenses, and capital expenditures that may occur due to lease renewals, market conditions, or property improvements. You can use a spreadsheet or a software tool to create a cash flow projection table that shows the NOI and the cash flow after debt service (CFADS) for each year.

3 Determine discount rate

The third step is to determine the discount rate that you will use to discount the future cash flows to the present value. The discount rate reflects the required rate of return that you or a potential buyer would demand to invest in the property, considering the risk and opportunity cost of the investment. The discount rate can be estimated using various methods, such as the capital asset pricing model (CAPM), the weighted average cost of capital (WACC), or the build-up method. You will also need to consider the market risk premium, the risk-free rate, the debt-to-equity ratio, and the cost of debt and equity.

4 Calculate present value

The final step is to calculate the present value of the future cash flows and the terminal value using the discount rate. The present value of the future cash flows is the sum of the discounted CFADS for each year. The present value of the terminal value is the discounted value of the estimated property value at the end of the holding period. You can use a formula or a function in a spreadsheet or a software tool to perform the calculations. The sum of the present value of the future cash flows and the present value of the terminal value is the estimated value of the property using DCF analysis.

5 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?