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Rohit Kishore: Lecturer in the School of Land Economy, University of Western Sydney, Blacktown, New South Wales, Australia
Introduction
This study empirically examines two contemporary issues regarding discounted cash flow (DCF) analysis in property investment valuations. The first issue is whether it is valid to use DCF analysis in property investment valuations. The second issue is whether it is appropriate to discount future cash flows using discount rates based on long-term bond yields.
Validity of DCF analysis of property investments
There is ongoing debate in the field of property valuation on the validity of DCF analysis in the valuation of property investments. A rational argument on validity of any valuation method should have regard to the behaviour of the investors in the market considered. A good valuation method should encapsulate the economics of the investment decisions. Therefore, on the validity of DCF analysis for property investments, the real question asked should be whether DCF analysis is used by the property investors as an investment decision-making tool. Further, if used, for what type of decision making it is used (for example, when deciding to acquire property or dispose of property or for performance comparison purposes). The answers to these types of questions should determine the valuation method(s) used; because the essence of any valuation is that it should reflect the market value and not create value per se. Therefore, if investors are using the DCF method to make property investment decisions, then can DCF analysis simulate the behaviour of property market participants and thus be the correct approach in determining the value.
Various writers have undertaken studies to ascertain whether or not DCF is used by property investors as a decision-making tool. McIntosh (1993) carried out an intensive survey of major Australian investors on the use of DCF, and reported that 75 per cent of the respondents always used DCF and 25 per cent usually used DCF analysis in the valuation of properties over $25 million. For acquisition purposes, all of the respondents indicated that they always used DCF. For comparison with other forms of investments, 60 per cent indicated that they would always use DCF, 20 per cent indicated that they would usually use DCF, and the remaining 20 per cent said that they...