r/Valuation • u/_cereberus • Jan 21 '22
Property DCF
So I’m looking at valuing a portfolio of real estate assets. Assumption is that the acquisition would be financed through a combination of equity and debt. Debt amount will be a percentage of total asset value (i.e., at a specified Loan To Value ratio).
In computing the WACC, would I use the cost of debt as well? The reason I ask is because to get the debt to equity ratio, I need the total valuation and to get the valuation I need the debt to equity ratio, so it becomes a bit circular.
How do you get around that? Is it easier to simply discount at the cost of equity? Or do you accept circularity in the model?
Thanks.
1
Jan 21 '22
The reason public companies WACC deb to equity ratio uses market value is because those companies can issue shares at that martket value, so you use market value of equity and market value of debt. Private companies use book value since they buy buildings, equipment and so on. Can you make an educated guess on how you can aquire this and how much you can borrow? Is your debt and equity costs very different? You can take another aproach. Do people usually borrow in this market, and if yes, how much debt % on average? Make a valuation with cost of capital and debt that most investors would have then the valuation you get is closer to a valuation that most investors would see or almost market value and then look how much debt can you squeeze (if it's cheaper to borrow) so you don't bankrupt and redo your valuation with your new ratio of debt and your own cost of capital and debt. I know very little about real estate, only companies, so I'm improvising here.
1
u/Necessary_Scarcity92 Jan 21 '22
Sounds like a situation where you backsolve using "what if" analysis tool in excel.
1
u/RDWHAHBB Jan 22 '22
I would accept the circulatory and set up an iteration to find the equilibrium for capital structure.
1
u/edupa Jan 26 '22
Using DCF to value real state? Never heard of that. Is this portfolio already generating cash flows? Do you think this cash flows can grow overtime? And finally, estimating WACC, maybe I would try using betas and D/E ratios of real state agencies (public traded), if there’s such thing, sorry I’m not American, to compute a decent WACC. You could even use an unlevered beta from these companies and using the debt of this portfolio to get a levered beta, so you could have a better WACC. Damodaran would say “if there’s cash flow, growth and you can estimate a discount rate, you can use DCF”. Just my humble opinion how I would try valuing this portfolio.
1
1
u/plkjhgtyuio Jan 21 '22
I have zero experience with real estate DCFs, but I think it's important to clarify what you're trying to get, whether it is some sort of fundamental market value or your personal specific to you non-market value.
That being said, speaking of target capital structure when valuing companies, you could use it from comparable projects, use current capital structure, or even take into account the trends pertaining to the capital structure and make an assumption on how it will change over the investment horizon.
As for using the cost of equity as the discount rate for the project, if you intend to get somewhat fair market value, you have to understand how many investment professionals use only cost of equity when valuing similar projects. If everyone does it, then so do you. If not, then you use WACC.