Cap rate - Discount Rates - Growth Rate for REITS

CFA Level II
#1

I’m consufed about what to use.

In one problem they give you the “Going-in Cap rate”

and in another problem, they give you the " Cap rate and growth rate"

when valuing real estate investments. I know the Terminal value should be discounted by (R -g) --> cap rate or going in cap rate?

but when using a P/AFFO multiples they used the Discount rate to discount the terminal value —>

Discount rate = cap rate + growth rate

SO CONFUSED!

#2

RASEC! You’re racing through these topics so quickly - every day you’re onto another one! - you’re making me feel bad that I’m still trying to slog my way through quant. I’m so bloody toast.

#3

Lammy!

I almost fainted the other day walking to lunch!

I hate this so much

:frowning:

#4

S2000magician

  • can you help me out with this one?
#5

It’s all about Gordon growth.

Cap rate = discount rate − growth rate, by definition. Thus, discount rate = cap rate + growth rate.

The going-in cap rate is used, well, going in; for the terminal value, you will use the terminal cap rate (which is likely different). If they give you “going-in cap rate” and “cap rate”, I’d assume that the latter is the terminal cap rate; what else could it be?

#6

Here is the question:

REOC:

Expected AFFO in Yr 8 = 13.5M

Holding Period = 7 years

PV of all dividends for 7 years = 39.7

Cap rate = 7%

Growth = 2.5%

Price to AFFO = 12x

My logic here was:

  • Get terminal value : 13.5 x 12 = 162 --. terminal value in Yr8.
  • Discount back to Yr 7 using the your normal (Re - g). Using your statement above Cap rate = discount rate − growth rate; 7 = x - 2.5; Re=9.5.
  • *** In my mind, the Cap rate is the rate to discount the terminal value
  • 162 / .07 = 2314.28 value at time 7.
  • discount 2314.28/ (1.095)^7 = 1126.07
  • 1126 + 39.7 =1265.0 ~~ 126.5 ***WRONG***

Here is what the answer in the vigenette said:

  • Terminal value estimate = 12 x 13.5 = 162 for the end of year 7
  • The discount rate is the Cap rate + Growth rate = 9.5% **this counting the terminal value at the Cost of Equity, instead of the Re - G or cap rate…WHYYYYYY??? OH GOD WHYYY??? ****
  • Discounting this terminal value to find the Present value: FV =162; N=7, I=9.5%; PV =85.83
  • add the PV of dividends = 85.83 + 39.7 = 125.53
#7

I don’t understand the _ bold, italic _ part, but the rest is obviously correct.

You’re getting this stuff! Good for you!

#8

S2000magician

I’m going crazy! I thought I had it…but I looked at my answer and it was wrong! Please look at my revised post. My logic is OFF :frowning: “crying inside”

#9

In a previous problems they divide the terminal value by (re-g) or what I call the cap rate

Problem: Expected NOI 1-7 = 7M

Expected NOI year 8.5

Required return on equity investment = 10%

NOI growth rate after 8 years

This was easy to calculate was your normal GGM.

  • here the terminal value is discounted at Re-g
  • and the cash flows are discounted at 10%

****I THINK MY ERROR IS THAT WHEN GIVEN A MULTIPLE HERE IS NO NEED TO DISCOUNT BY (Re-g) as that is the terminal value.****

#10

You’re correct: you don’t divide the terminal value by (re − g), you divide the terminal cash flow by (re − g) to _ get _ terminal value.