Commercial Real Estate Finance

Posts Tagged ‘discounted cash flow’

The typical approach to analyze potential real estate investment and development opportunities is the discounted cash flow model. In the most basic sense, the user makes input assumptions such as purchase price, LTV, NOI growth, terminal cap rate, and expense growth to get the outputs: Internal Rate of Return and Net Present Value. The standard decision rule is that if IRR is higher than the investors required rate of return and the NPV is positive, then the investment should proceed. To supplement this decisions making process, a sensitivity analysis is often conducted. To create a sensitivity analysis the user changes various inputs and records their effect on the output Ceteris paribus. There are several limitations with the DCF model, including that the value of the property is needed to compute the discount rate, the discount rate is assumed to be constant during the entire holding period, and uncertainty is not explicitly taken into account.

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