An appraiser is developing a discounted cash flow (DCF) model for a newly constructed office building with a 7-year holding period. The property is expected to generate net operating income (NOI) of $250,000 in Year 1, increasing at 3% annually thereafter. The reversion value at the end of Year 7 is estimated at $4,200,000 using a terminal capitalization rate of 6.5%. The investor’s required yield (discount rate) is 7.2%. Which component of the DCF model must be discounted using the 7.2% rate?
Correct Answer
C) All future cash flows — both annual NOI and the reversion — must be discounted at 7.2%
Under USPAP Standards Rule 1-4 and the Income Approach guidance in the Appraisal of Real Estate (15th ed.), all future benefits (i.e., each year’s NOI and the reversion) must be discounted to present value using the investor’s required yield (discount rate) — here, 7.2%. The 3% is the NOI growth rate, not a discount rate; it affects the magnitude of each year’s NOI but not the discount rate applied. Using different rates for different components violates the internal consistency requirement of a DCF model.
Why This Is the Correct Answer
Under USPAP Standards Rule 1-4 and the Income Approach guidance in the Appraisal of Real Estate (15th ed.), all future benefits (i.e., each year’s NOI and the reversion) must be discounted to present value using the investor’s required yield (discount rate) — here, 7.2%. The 3% is the NOI growth rate, not a discount rate; it affects the magnitude of each year’s NOI but not the discount rate applied. Using different rates for different components violates the internal consistency requirement of a DCF model.
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NOI is $154,000 and the market overall rate is 6.8%. The indicated value is:
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In a discounted cash flow analysis for a ground lease with 40 years remaining, the appraiser projects level annual ground rent of $120,000 and estimates a reversion (fee simple value at lease expiration) of $3,000,000. The appraiser selects a 5.0% yield rate for the leasehold interest. Which statement accurately describes how the reversion is treated in this analysis?