Comparison of the DCF and German income approach
| DOI | https://doi.org/10.1108/JPIF-04-2018-0025 |
| Pages | 58-71 |
| Date | 14 December 2018 |
| Published date | 14 December 2018 |
| Author | Jan Reinert |
| Subject Matter | Real estate & property,Property management & built environment |
Comparison of the DCF and
German income approach
Jan Reinert
IREBS International Business School, University of Regensburg,
Regensburg, Germany
Abstract
Purpose –The majority of institutional investors in Germany use the German income approach (GIA) while
investors abroad prefer the discounted cash flow (DCF). The debate around the two methods has been largely
theoretical, lacking large-scale empirical evidence. The paper aims to discuss this issue.
Design/methodology/approach –The analysis consisted of a performance comparison and hedonic
regressions based on ordinary least squares. Fitted GIA and DCF values were obtained for all observations in
the data set in order to eliminate distortions caused by different property characteristics in the two valuation
sub-samples.
Findings –The research hypothesis, stating that the two methods result in statistically identical estimations
of value, was rejected. The performance analysis showed that GIA valuations displayed smoother total return
performance due to less volatile capital growth in comparison to DCF valuations. Comparing the fitted values
obtained from the regressions showed that GIA valuations were on average lower than their DCF
counterparts. The difference was small and both methods resulted in very similar fitted values. The difference
between fitted values was not constant over time and decreased toward the end of the analysis period.
Practical implications –The research adds empirical arguments to the ongoing debate between GIA and
DCF valuations. So far empirical proof has been scarce or one-sided.
Originality/value –This analysis is the first large-scale empirical comparison of the DCF and the GIA
within the same market.
Keywords Germany, Valuation, Appraisal, DCF, Income approach
Paper type Research paper
Introduction
Property valuations play a key role in the real estate market and are used for a variety of
reasons, such as purchase and sale decisions, mortgage lending, pricing of shares, insurance
premiums or taxes. Their most common use in the real estate investment universe is as
proxies for market prices (Baum, 2009). Due to the peculiarities of real estate, property
values are not readily observable on the market and valuations are used as surrogates for
transactions that did not take place.
There is an ongoing debate around the traditional German income approach (GIA) of
property valuation and internationally applied methods such as the discounted cash flow
(DCF). In Germany, the majority of institutional investors uses the traditional valuation
method known as Ertragswertverfahren (literally translated as earnings-value-technique)
while investors abroad rely on DCF approaches. This paper represents the first large-scale
empirical comparison of the two methods under the same conditions. So far, research into
the GIA has remained largely theoretical and the few existing empirical analyses lack
suitable comparisons. Due to an increasing number of German investors employing DCF
appraisals, it was possible to compare the two methods directly under the same market
conditions. The objective of this paper is to investigate how German valuations according to
GIA differ from German DCF valuations and to add empirical insights to the ongoing debate
between mostly German proponents and mostly international opponents of the GIA.
Journal of Property Investment &
Finance
Vol. 37 No. 1, 2019
pp. 58-71
© Emerald PublishingLimited
1463-578X
DOI 10.1108/JPIF-04-2018-0025
Received 22 April 2018
Revised 25 June 2018
Accepted 30 July 2018
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1463-578X.htm
The authors would like to thank to MSCI/IPD for the generous access to their databank, and also to
Steffen Sebastian from the University of Regensburg and the participants of the ERES and ARES
conferences, in particular Neil Crosby and Colin Lizieri, for their support and feedback. No research
funding from external sources has been used in this research.
58
JPIF
37,1
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