June 2012
Investigating the difference
between discounted cash flow
and German income approach
Jan Reinert
Property Portfolio Analyst
IPD Germany
jan.reinert@ipd.com
Phd Candidate
International Real Estate Business School
jan.reinert@wiwi.uni-regensburg.de
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© IPD 2012
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© IPD 2012
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© IPD 2012
o
RICS IPD Valuation and Sale Price Report 2011
How much does sale price differ from previous valuation?
France:
8.8%
Netherlands:
UK:
12.5%
Germany:
11.8%
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 framework
The 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, rent
o 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 perpetuity
o 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 using
o 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 regular
o discount rates depending on the value of the land and the
o 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
o
o
o
o
o
o
o
Supplied by IPD
Time Period: 2003 – 2011
15,036 Observations
3,384 Properties
80 Portfolios
Only Investors based in Germany
Including office, retail, mixed used and industrial properties
Available information:
o
o
o
o
o
o
o
o
o
o
o
o
o
Appraisal method
Appraised capital value
Purchase/Sale information
Passing rent (as stated in contract)
Estimated market rent
Area in sqm
Economic age
Vacancy rate at year end
Primary use
Location
Annual total return
Annual income return
Annual capital value growth
15%
4%
Office
Retail
22%
59%
Office/Retail
Industrial
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
Performance Measure Analysis
10
GIA
5
0
-5
-10
2003
2004
2005
2006
2007
2008
2009
2010
INCR
10
2011
CVG
DCF
5
0
-5
-10
2003
2004
2005
2006
2007
2008
2009
2010
2011
TR
6
Capital Value Growth
4
2
0
-2
-4
-6
-8
-10
-12
2003
2004
2005
2006
2007
DCF
2008
GIA
2009
2010
2011
Regression Analysis
lnprice
lnvalue
y04
…
y11
Coefficient
0.011
…
0.003
St. Err.
0.013
…
0.017
P>t
0.405
…
0.841
Coef.
-0.010
…
-0.016
St. Err.
0.004
…
0.004
P>t
0.009
…
0.000
lnquality
lnrent
lnage
0.780
0.208
-0.074
0.127
0.072
0.014
0.000
0.004
0.000
0.996
0.091
-0.043
0.011
0.009
0.004
0.000
0.000
0.000
lnvacancy
lnarea
large
small
retail
indus
mixed
st
…
th
_cons
dcf_y03
…
dcf_y11
-0.013
0.760
0.015
-0.018
0.019
-0.126
0.039
-0.054
…
-0.087
1.402
0.015
0.088
0.019
0.015
0.009
0.040
0.008
0.025
…
0.043
0.231
0.383
0.000
0.428
0.236
0.030
0.002
0.000
0.028
…
0.043
0.000
-0.009
0.932
-0.003
0.023
-0.010
-0.076
0.014
-0.022
…
-0.035
0.974
-0.047
…
-0.018
0.002
0.010
0.005
0.005
0.003
0.011
0.003
0.006
…
0.010
0.033
0.038
…
0.008
0.000
0.000
0.561
0.000
0.000
0.000
0.000
0.000
…
0.000
0.000
0.225
…
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
25
Price of an average office property in Frankfurt
24.6
24.1
24
23.7
In mln. Euro
23
22
21.9
21.4
21.6
21
20
19
2003
2004
2005
GIA Valuations
2006
2007
Transactions
2008
2009
DCF Valuations
2010
2011
25
Price of an average office property in Frankfurt
24
in Mln. Euro
23
22
21
20
19
GIA Valuations
Transactions
DCF Valuations
Including all observations:
Simple Average Deviation from Valuation
(Transaction - Valuation) / Valuation
2003 2004 2005 2006 2007 2008 2009
DCF 34.8% 18.1% 16.0% 11.6% 36.0% 23.5% 8.6%
GIA -8.4% -3.8% -1.4% -9.7% -1.7% 0.8% 7.9%
All
St.
2010 2011 Years Dev.
6.3% 1.2% 16.1% 117.2%
0.3% -5.4% -6.8% 32.8%
Excluding the top and bottom 5%:
Simple Average Deviation from Valuation
(Transaction - Valuation) / Valuation
DCF
GIA
All
St.
2003 2004 2005 2006 2007 2008 2009 2010 2011 Years Dev.
9.3% 15.1% 15.2% 6.4% -0.3% 5.2% 5.8% 1.1% -1.5% 4.3% 20.8%
-9.4% -7.2% -5.0% -11.1% -6.2% -3.1% -0.2% -6.6% -9.6% -6.8% 12.8%
Simple Average Deviation from Valuation
(Transaction - Valuation) / Valuation
DCF
GIA
All
St.
2003 2004 2005 2006 2007 2008 2009 2010 2011 Years Dev.
9.3% 15.1% 15.2% 6.4% -0.3% 5.2% 5.8% 1.1% -1.5% 4.3% 20.8%
-9.4% -7.2% -5.0% -11.1% -6.2% -3.1% -0.2% -6.6% -9.6% -6.8% 12.8%
15%
10%
4.3%
5%
0%
-5%
-6.8%
-10%
-15%
2003
2004
2005
2006
2007
GIA
2008
DCF
2009
2010
2011
All years
Absolute Average Deviation from Valuation
(Transaction - Valuation) / Valuation
2003
2004
2005
2006
2007
2008
2009
2010
All
2011 Years
St.
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%
25%
20%
14.6%
15%
12.1%
10%
5%
0%
2003
2004
2005
2006
2007
GIA
2008
DCF
2009
2010
2011
All years
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 larger
o 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 prices
o going to decrease further?
June 2012
Jan Reinert
Property Portfolio Analyst
IPD Germany
jan.reinert@ipd.com
Phd Candidate
International Real Estate Business School
jan.reinert@wiwi.uni-regensburg.de