A holding period in a DCF is typically chosen to reflect:
Correct Answer
A) A typical investor's expected ownership span
For a market-based DCF, analyze the investment horizon relevant to typical market participants and the property. The holding period need not equal the mortgage term, accounting depreciation period or remaining economic life. Those factors may inform the forecast without automatically determining the horizon.
Why This Is the Correct Answer
Option A is correct because, in DCF analysis, the projection period is an investor's anticipated holding period, the time the investor expects to own the property before selling it. A market-value DCF models the horizon relevant to typical market participants for that type of property.
Why the Other Options Are Wrong
Option B: The remaining economic life of the improvements
Option B, the remaining economic life of the improvements, is a time frame used in some capitalization contexts, but a DCF holding period is the investor's expected ownership span, which is usually shorter and ends with a resale. Economic life may inform the forecast without setting the horizon.
Option C: The term of the property's existing mortgage
Option C, the term of the existing mortgage, reflects a financing arrangement, not the typical investor's expected ownership period. A holding period need not match a loan term.
Option D: The period required to fully depreciate the building
Option D, the period to fully depreciate the building, is an accounting or tax concept, not an investor's expected ownership span. Depreciation schedules do not determine the DCF horizon.
Hold until you sell
The holding period is simply how long a typical buyer plans to hold the property before selling it.
How to use: Use this phrase to pick the holding period over loan, tax or life-based periods.
Exam Tip
Answers tied to financing terms or tax depreciation describe other concepts; the DCF horizon is about the typical investor's ownership plans.
Common Mistakes to Avoid
- -Matching the holding period to the loan term
- -Using the tax depreciation period as the DCF horizon
- -Equating the holding period with the building's remaining economic life
Concept Deep Dive
Analysis
This question tests what the projection period in a market-based DCF represents. The holding period reflects how long a typical investor expects to own the property before selling, not loan, tax or physical-life periods.
Background Knowledge
In yield capitalization, income is forecast over a projection period and the property is assumed to be sold at the end, producing a reversion. For market value, that period should reflect the expectations of typical buyers in the market for the property type.
Real-World Application
An appraiser surveys brokers and investors in the apartment market and finds buyers typically plan to hold for a period of several years. She sets her DCF projection to that holding period and estimates a reversion at the end.
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