Discount Rate?
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[{"id": "fw8y2yn", "text": "What is your expected rate of return of your money?", "replies": [{"id": "fw8ybe1", "text": "Good question. Let\u2019s assume I\u2019m underwriting for a fund. Is this varying from terminal cap rate and growth rate. Thank you", "replies": [{"id": "fw8yj6l", "text": "He wasn't asking you the question he was providing you the answer.", "replies": [{"id": "fw9e288", "text": "Kids these days", "replies": [], "depth": 4}], "depth": 3}, {"id": "fw9fh43", "text": "Your terminal cap rate is the market cap rate of the property when you sell/refinance.\nGrowth rate (usually) refers to the rate of growth in rents.\nWhile they will implicitly affect your discount rate, they aren't the same thing.\n\n\nYour discount rate depends on who you are. Are you an insurance company looking to deploy $1B in class A markets? Your rate will be a lot lower than a guy flipping $50K houses in Minnesota.\n\nYour discount rate depends on your certainty (or optimism) in the future. Are you buying property in central London or Mogadishu? \n\nIt depends on inflation. Is your currency the US dollar or Lebanese pound?\n\nMore than anything else, it depends on your next best alternative, which is why I asked that question. For many people, a good benchmark is US equities, which historically returns 6-8%.\n\nYou're not going to get an exact answer because there isn't a \"right\" answer, it depends on a variety of factors. That's part of the art of underwriting a real estate deal. People get paid the big bucks to decide on a discount rate, whether it's pulled from the mind, heart, or ass (usually a combination)\n\nIf you want something close to the \"right\" answer you have to ask your peer group, or look at the cap rates for comparable properties and add some inflation/uncertainty factor. If you just taking a shot in the dark, as an American, 8-9% is probably a reasonable discount rate", "replies": [{"id": "fw9h6w0", "text": "Great response CuntJuggler. Ask your peers and maybe look into some investor sentiment reports like (for the U.S.) the PwC Real Estate Investor Survey ($$$$) or free reports from CBRE like the North American Cap Rate Survey come to mind.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fw9kk3q", "text": "For quick, back of the napkin stuff I usually do +75 or 100 bps over reversion cap. For reversion I\u2019d do +50 bps over going in cap. \n\nSo a Class A office might be 6% going in, 6.5% reversion, 7.5% discount.   \n\nOnce I learn more about above or below market rent, turnover, capex, etc I can move my spreads around.", "replies": [], "depth": 1}, {"id": "fw9sr4g", "text": "Assume a higher discount rate for more risky asset classes.  In this period that is likely to be retail and hotels.", "replies": [{"id": "fwajc9f", "text": "Correct. However how do you quantify that. Do you look at the current 10-year Treasury Bill rates, Risk-Free Premium, etc. To assess that? That's what is confusing me.", "replies": [{"id": "fwax1x0", "text": "The textbook definition adds the inflationary factory to your cap rate \u2014 typically CPI unless you have a market-specific number.\n\nEDIT: In practice, professionals will reference the spread between cap rates and discount rates in an investor survey typically sent out by PwC.", "replies": [], "depth": 3}, {"id": "fwbnw7w", "text": "If your hold period is 10 years then use the 10-year Treasury as your risk free rate of return.  You need to include inflation and all expenses.", "replies": [{"id": "fwe33w3", "text": "The 10 year treasury isn\u2019t typically the relevant metric for the spread between cap and discount rate. Nominal discount rates adjust for inflation. \n\nA good example of why the treasury wouldn\u2019t work is the current 10-yr \u2014 only 65 bps when inflation over the next 10 years is imminent due to Fed spending during the crisis. Your spread would be thin between cap and discount if you use the 10-yr as a buffer even though future cash flows are risky.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fwacamu", "text": "This is usually how I describe discount rates, based largely on the Real Estate Investors Desbook (Arnold). \n&gt;The selection of a discount rate is largely dependent on the financial requirements of a developer - it will vary based on changes to the cost of money, general real estate risk, developer experience, project location, market conditions, and lender security. Because of the myriad of internal and external factors that can affect a discount rate, there are no universally accepted discount rates. A higher discount rate reflects more risk associated with market conditions, owner experience, and location, among other factors. Finally, because a discount rate mirrors an investment\u2019s internal rate of return, and therefore a developer\u2019s return on equity, the discount rate is largely a factor of a developer\u2019s required returns.", "replies": [], "depth": 1}, {"id": "fwaq64w", "text": "Discount rates in CRE are different from discount rates in corporate finance - there is no CAPM for properties. This tripped me up so hard when I started because I kept feeling like I was missing the CRE equivalent of the CAPM formula. Turns out, discount rates are just set by funds and the market. So the target rate is set by the market - what rates of return are other funds expecting on this type of property in this market? And if you clear the hurdle, then that's a positive sign for the project.", "replies": [], "depth": 1}, {"id": "fwb14jz", "text": "It\u2019s the unlevered IRR", "replies": [], "depth": 1}, {"id": "fwb3nml", "text": "For real property, Cap rate plus appreciation rate. For financial asset, use capital asset pricing model, CAPM...", "replies": [], "depth": 1}]