In this section, we will learn about the Income Approach in detail.
The income approach is suitable for income-generated property. It allows investors to estimate the market value of the property based on property income. The following are the two commonly used methodologies to assess the value of income-generated property.
- Discounted Cash Flow Method also known as the DCF Method.
- Income Capitalization Method also known as the IC Method.
Table of Contents
Now, we will discuss each method in a little detail.
The Discounted Cash Flow Method (DCF Method)
It is nothing but discounting future cash flow, including the terminal value to arrive at the present value of the property
Discounting
Discount Rate or Weighted Average Cost of Capital (WACC)– the expected rate of return from a project.
For illustration purpose, refer to the following formula and sample used for the calculation of the WACC rate:
Future Cash Flow
Projected future cash flow for the period of 5 to 15 years. Note that, the number of years primarily depends on various factors including, property, demand & supply in the market, client or developer-specific requirements, valuer assessment, etc.
Terminal Value or Capitalization Value
The sale value of the property at the time of exit. For illustration purpose, refer following formula and sample used for the calculation of the Terminal value
Where:
- Cap Rate: Expected yield from the sale of asset at the time of exit
- NOI: Total Income – Total Operating Expenses
Present Value
The value of the property as of a particular date
For illustration purpose, refer to the following Excel formula used for the calculation of NPV:
Where:
- Rate: Discount Rate or WACC rate
- Values: future projected cash flows
- Dates: Schedule of payment dates that corresponds to the cash flow
Income Capitalization Method (IC Method)
It determines the value of the property based on the immediate one-year net operating income (NOI).
Under the IC Method, the value of the property is determined by dividing the NOI of the property by the Capitalisation Rate.
Key points to be noted
- DCF methodology can also be adapted for under-construction property or proposed development, depending on the client or developer’s requirement, valuer assessment, etc.
- The Cost of Equity primarily depends on the construction status, approval status, developer profile, location of the property, demand & supply in the micro market, etc.
- The Cost of Debt will be considered based on the current lending rates prevailing in the market
- Capitalization Rate can be determined by benchmarking similar property sale transactions in the market
