Valuing specialised property using the DCF profits method
| DOI | https://doi.org/10.1108/JPIF-06-2016-0047 |
| Date | 05 September 2016 |
| Pages | 641-654 |
| Published date | 05 September 2016 |
| Author | David Jansen van Vuuren |
| Subject Matter | Property management & built environment,Real estate & property,Property valuation & finance |
PRACTICE BRIEFING
Valuing specialised property
using the DCF profits method
David Jansen van Vuuren
Specialised Valuers, Cape Town, South Africa
Abstract
Purpose –The purpose of this paper is twofold: primary, to argue that the profits method, specifically a
discounted cash flow (DCF)-based profits method, should be the preferred method of valuation when valuing
specialised property. Secondary, to make technical recommendations in the application of the method.
Design/methodology/approach –Literature was reviewed on the theory of the profits method as
well as physical valuations performed in practice. Improvements for the profits method are suggested
from the review of six valuations conducted in South Africa in the specialised property sectors.
A qualitative approach is followed in the research as broad principles are extracted from the valuation
reports as implications and improvements for the profits method.
Findings –The profits method is more flexible and sophisticated than the cost approach in taking into
account systematic and unsystematic risk. The profits method is more accurate than the cost approach
in delivering a true reflection of the value of specialised property for any purpose but specifically for
mortgage lending purposes and reduces the credit exposure risk of financial institutions. It also
decreases pricing inefficiencies to be exploited by buyers and sellers.
Practical implications –Three improvements to the profits method are suggested. First, revenue could
be forecasted based on a probability-weighted approach. Second, a modified capitalisation rate is suggested
to the capitalisation rate formula in the calculation of G. Third, a market rental aggregation anchoring and
judgement-based approach is suggested as rationale for determining the hypothetical rental split.
Originality/value –There seems to be a general lack in literature on the profits method of valuation
and its application to specialised properties, specifically a DCF-based approach, with this paper being a
technical contribution to the body of knowledge on this topic.
Keywords Cost, Profits, Valuation, DCF, Rental, Specialized
Paper type Technical paper
1. Introduction
Real estate is composed of specialised and non-specialised properties (French, 2004,
pp. 538-539). Non-specialised properties generally include residential, commercial,
industrial and some forms of retail. Specialised properties generally have limited
comparative market data available, being idiosyncratic, with the business inextricably
linked to the property for a single overall utility and can include silos, production plants
(e.g. chemical, fruit extraction fertilizer, etc.), hospitals, hotels, filling stations, health
clubs and many more.
In valuing specialised property, there are only two overall approaches that are
considered suitable, namely, the profits approach and the cost approach. However, the
profits approach can be performed as a one-year in perpetuity method or as a
discounted cash flow (DCF) method. In turn, the cost approach is a combined use of the
depreciated replacement cost (DRC) method and the sales comparison method. This
paper argues that the DCF profits method is the most suitable in most instances.
2. Overview of terms
The following meanings are ascribed to terms used in this paper.
Journal of Property Investment &
Finance
Vol. 34 No. 6, 2016
pp. 641-654
©Emerald Group Publis hing Limited
1463-578X
DOI 10.1108/JPIF-06-2016-0047
Received 30 June 2016
Accepted 13 July 2016
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1463-578X.htm
641
Valuing
specialised
property
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