A discount rate for a DCF may be supported by:
Correct Answer
C) Investor surveys and rates extracted from comparable sales
In a market-value DCF, relevant investor surveys and appropriately analyzed comparable transactions can support a discount rate consistent with forecast cash flows and risk. Survey averages are not automatic answers. A particular client’s target or prime lending rate alone does not establish the market-required property yield.
Why This Is the Correct Answer
Option C is correct because investor surveys and rates extracted from comparable sales reflect what the market requires for similar properties. Yield or discount rates can be derived from comparable sales by finding the rate that equates the present value of anticipated cash flows with the sale price, and investor surveys report the rates participants are using. These are evaluated against the subject's risk, not adopted mechanically, but they provide market support.
Why the Other Options Are Wrong
Option A: The client's own required rate of return on the transaction
Option A, the client's own required rate of return, reflects one party's investment target rather than the market. A market value discount rate should reflect typical market participants, not a particular client's goals.
Option B: The property's historical appreciation alone
Option B, the property's historical appreciation alone, looks backward at price change and ignores the forecast cash flows and risk that a discount rate must reflect. Past appreciation does not by itself establish what investors require now.
Option D: The current prime lending rate by itself
Option D, the current prime lending rate by itself, is a short-term lending benchmark, not the total return investors require from real property. It does not capture the property's equity risk, illiquidity or management burden.
Ask the market, not the client
A market value discount rate comes from what the market shows in sales and surveys, not from one client's wish or one loan rate.
How to use: Use it to eliminate choices based on a single party's target or a single benchmark rate.
Exam Tip
Watch for words like alone or by itself; a single narrow benchmark is rarely enough to support a market discount rate.
Common Mistakes to Avoid
- -Adopting the client's target return as the market discount rate
- -Using the prime rate as if it were a property yield rate
- -Treating a survey average as an automatic answer without considering subject risk
Concept Deep Dive
Analysis
This question tests the sources an appraiser can use to support a market-based discount rate in a DCF. A market value discount rate should reflect what typical investors require for similar property risk. Investor surveys and yields extracted from comparable sales provide that market evidence, while one client's target or a single lending rate does not.
Background Knowledge
A discount or yield rate converts forecast cash flows and reversion into present value. In market value work, it should be supported by market evidence, such as yields extracted from comparable sales through DCF analysis and published investor surveys, considered in light of the subject's risk.
Real-World Application
An appraiser valuing a multi-tenant office building reviews current national investor surveys and extracts yield rates from recent sales with known projections. The appraiser reconciles these to a discount rate consistent with the subject's location and tenancy risk.
More Income Approach Questions
Which model describes yield capitalization of property benefits?
An appraiser is valuing a duplex. A market survey of recent duplex sales reports prices at 10.8 times potential gross income, with stabilized vacancy and credit loss of 10% of PGI and no other income. The subject's rent schedule is unavailable, but the property manager's records show collected income of $54,000 a year, in line with market rent and the 10% market loss. What value is indicated?
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Annual PGI is $360,000 and combined vacancy and collection loss is explicitly 8% of that same PGI base. There is no other income. What annual EGI remains?
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In the subject's market, lenders on fourplexes have lowered their typical loan-to-value ratio from 70% to 60%. The annual mortgage constant remains 5% and the equity dividend rate remains 10%. The subject's NOI has not changed. How does this affect the overall rate indicated by the band of investment and the indicated value?
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Previous Question
Year 11 NOI is projected at $385,000. Capitalize it at 7% to estimate a gross sale at the end of year 10. There are no selling costs. Discount that single reversion for 10 years at 8.5% annually. What is its present value, rounded to the nearest dollar?
Next Question
An appraiser is deriving a monthly gross rent multiplier from the cash sale of a duplex that was listed at $525,000 and sold for $504,000. Its combined rent of $3,000 per month includes water, gas and electricity paid by the owner, and paired rentals show that this arrangement adds $200 to the combined monthly rent. The subject duplex rents for $2,600 per month, and its tenants pay their own utilities. What multiplier does the sale indicate on the subject's rent basis?