investigating the difference between discounted cash flow and german income approach jan reinert...
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Investigating the difference between discounted cash flow and German income approach
Jan Reinert
Property Portfolio Analyst Phd CandidateIPD Germany International Real Estate Business [email protected] [email protected]
June 2012
© IPD 2012
© IPD 2012
© IPD 2012
o RICS IPD Valuation and Sale Price Report 2011How much does sale price differ from previous valuation?
France: 8.8% Netherlands: 11.8%UK: 12.5% Germany: 14.2%
o Crosby (2007) German open ended funds: was there a valuation problem?Valuations in the UK are more objective and conceptually correct than in Germany.Over-valuations during recessions are more likely in Germany than in other markets.
o Weistroffer (2010) The German open end fund crisis – A valuation problem?German valuation standards result in a smoothing effect which contributed to the open-
ended fund crisis of 2005/2006.
o Glaesner, Thomas and Schiereck (2010) Lack of German real estate fund volatility – is the market or the valuer to blame?
In contrast to the UK, German fund managers have an interest in stable and smooth value changes. ( client influence)
o Schnaidt and Sebastian (2012) German valuation: review of methods and legal frameworkThe differences between the German and British capitalization approaches are not enough to explain any large difference in valuations and should yield comparable results.The German valuation approach is unlikely to be the reason for the observed anomalies.
o Term:
o Actual income and costs are forecasted for the near future
o Costs paid by tenants are excluded
o Includes special circumstances such as vacancies, rento reviews, rent free periods and new tenant fit outs
o Net cash flows are discounted at the appropriate rate
o Reversion:
o Expected future resale value (future net cash flow in perpetuityo at the appropriate rate) is discounted to the present
o Value of the land:
o Value as if vacant lot
o Benchmark land values based on comparison method usingo actual market transactions
o Infinite value
o Value of the building:
o Sustainable/market income and costs
o Finite value (if not upgraded) depending on economic age
o Liegenschaftszinssatz = Market Net Yield (differs from regularo discount rates depending on the value of the land and theo economic age)
German DCF valuations differ significantly from traditional German valuations (GIA) in terms of volatility and market accuracy.
DCF valuations experience more volatility and are better estimates of true market values GIA valuations produce better estimates for the German real estate market
German DCF valuations do not differ significantly from traditional German valuations
The German market is peculiar (see Switzerland) German DCF valuations are not real DCF valuations
German DCF valuations differ significantly from traditional German valuations (GIA) in terms of volatility and market accuracy.
DCF valuations experience more volatility and are better estimates of true market values GIA valuations produce better estimates for the German real estate market
German DCF valuations do not differ significantly from traditional German valuations
The German market is peculiar (see Switzerland) German DCF valuations are not real DCF valuations
o Supplied by IPDo Time Period: 2003 – 2011o 15,036 Observationso 3,384 Propertieso 80 Portfolioso Only Investors based in Germanyo Including office, retail, mixed used and industrial propertieso Available information:
o Appraisal methodo Appraised capital valueo Purchase/Sale informationo Passing rent (as stated in contract)o Estimated market rento Area in sqmo Economic ageo Vacancy rate at year endo Primary useo Locationo Annual total returno Annual income returno Annual capital value growth
A) Performance Measure Analysis
o Comparison of total return, income return & capital value growth for GIA and DCF valuations
B) Regression Analysis*
o Deriving hedonic indices for GIA and DCF valuations
o Using mass appraisals to derive transaction prices
o Comparing the difference between transaction prices and actual valuations
* see Weistroffer (2010)
Performance Measure Analysis
Regression Analysis
lnprice lnvalue
Coefficient St. Err. P>t Coef. St. Err. P>ty04 0.011 0.013 0.405 -0.010 0.004 0.009… … … … … … …
y11 0.003 0.017 0.841 -0.016 0.004 0.000
lnquality 0.780 0.127 0.000 0.996 0.011 0.000lnrent 0.208 0.072 0.004 0.091 0.009 0.000lnage -0.074 0.014 0.000 -0.043 0.004 0.000
lnvacancy -0.013 0.015 0.383 -0.009 0.002 0.000lnarea 0.760 0.088 0.000 0.932 0.010 0.000large 0.015 0.019 0.428 -0.003 0.005 0.561small -0.018 0.015 0.236 0.023 0.005 0.000retail 0.019 0.009 0.030 -0.010 0.003 0.000indus -0.126 0.040 0.002 -0.076 0.011 0.000mixed 0.039 0.008 0.000 0.014 0.003 0.000
st -0.054 0.025 0.028 -0.022 0.006 0.000… … … … … … …th -0.087 0.043 0.043 -0.035 0.010 0.000
_cons 1.402 0.231 0.000 0.974 0.033 0.000dcf_y03 -0.047 0.038 0.225
… … … …dcf_y11 -0.018 0.008 0.023
Obs. 1,914 12,665
Prob > F 0.000 0.000
R-squared 0.934 0.963
Adjusted R2 0.932 0.963
Simple Average Deviation from Valuation(Transaction - Valuation) / Valuation
2003 2004 2005 2006 2007 2008 2009 2010 2011All
YearsSt.
Dev.
DCF 9.3% 15.1% 15.2% 6.4% -0.3% 5.2% 5.8% 1.1% -1.5% 4.3% 20.8%
GIA -9.4% -7.2% -5.0% -11.1% -6.2% -3.1% -0.2% -6.6% -9.6% -6.8% 12.8%
Including all observations:
Excluding the top and bottom 5%:
Simple Average Deviation from Valuation(Transaction - Valuation) / Valuation
2003 2004 2005 2006 2007 2008 2009 2010 2011All
YearsSt.
Dev.
DCF 34.8% 18.1% 16.0% 11.6% 36.0% 23.5% 8.6% 6.3% 1.2% 16.1%117.2
%GIA -8.4% -3.8% -1.4% -9.7% -1.7% 0.8% 7.9% 0.3% -5.4% -6.8% 32.8%
Simple Average Deviation from Valuation(Transaction - Valuation) / Valuation
2003 2004 2005 2006 2007 2008 2009 2010 2011All
YearsSt.
Dev.
DCF 9.3% 15.1% 15.2% 6.4% -0.3% 5.2% 5.8% 1.1% -1.5% 4.3% 20.8%
GIA -9.4% -7.2% -5.0% -11.1% -6.2% -3.1% -0.2% -6.6% -9.6% -6.8% 12.8%
Absolute Average Deviation from Valuation(Transaction - Valuation) / Valuation
2003 2004 2005 2006 2007 2008 2009 2010 2011All
YearsSt.
Dev.
DCF 19.0% 20.3% 21.1% 19.6% 17.8% 17.0% 12.0% 10.3% 9.2% 14.6% 15.5%
GIA 13.3% 12.5% 11.7% 14.6% 11.4% 10.4% 9.5% 10.8% 12.7% 12.1% 7.9%
German DCF valuations differ significantly from traditional German valuations (GIA) in terms of volatility and market accuracy.
DCF valuations experience more volatility and are better estimates of true market values GIA valuations produce better estimates for the German real estate market
German DCF valuations do not differ significantly from traditional German valuations
The German market is peculiar (see Switzerland) German DCF valuations are not real DCF valuations
1) There seems to be a significant difference between traditional German valuations (GIA) and German DCF valuations.
2) The analysis suggests that the GIA produces more stable valuations than DCF appraisals.
3) GIA valuations tend to be on average above transaction prices while DCF valuations are on average below market prices.
4) When using simple averages DCF valuations appear to be better estimates of transaction prices.
5) When using absolute deviation from valuation GIA valuations seem to be on average closer to transaction prices.
o Model is likely to suffer from sample selection bias(Only certain properties (offer > reserve) result in a sale. This might explain the rising transaction prices of 2008 in the model) Heckman (1979)
o Are German DCF valuations „real“ DCF valuations?(50% of DCF valuations report „economic age“ which is only
relevant for the GIA method)
o Does the valuation method influence transaction prices?
o As more German investors are using DCF valuations a largero data set will be available in the future
(Possibility to carry out more in depth analyses over longer periods of time)
o Is the gap between DCF valuations and transaction priceso going to decrease further?
Jan Reinert
Property Portfolio Analyst Phd CandidateIPD Germany International Real Estate Business [email protected] [email protected]
June 2012