Why This Matters - Real World Application

Allow me to draw a direct connection between what you're learning in this course and what goes on in the real world of real estate.

As I stated in the introduction to this course. There are few tasks in real estate more common and universal than direct cap valuation. But what does that mean for you? Allow me to offer a list of examples of how this method is used.

Acquisitions

The Foles Case uses an acquisitions team as the setting for teaching the direct cap method, so this is a fair place to start.

Here's how an acquisition works in practice. A seller first makes the decision to sell a property. For mid to large-sized firms, this decision is generally made by the asset management team, with sign off from senior management. For smaller firms or tightly-held family offices, this decision is most often made by the principal/owner.

Once the decision has been made to sell, the seller estimates what price the property will likely bring in the market. This analysis usually involves either running a direct cap method alone, or in conjunction with DCF analysis. Once an internal valuation is done, the seller will usually engage several brokerage firms about possibly marketing the property.

Each brokerage firm will likewise run their own valuation analysis - again, using the Income Approach . The brokerage teams will then present their proposals to the seller, and based on the proposal the seller selects a broker.

The broker then prepares an offering memorandum, which may include an asking price. (Side note: the more sophisticated the buyer pool, the less likely an asking price will be included. Instead a "whisper price" may or may not be communicated to interested buyers).

The broker shares the offering with the market, and interested buyers (acquisition teams) will perform analysis similar to what we're doing in this course. Again, using a direct cap valuation as one metric to determine whether to chase a deal.

Mortgage Lending

Many lenders rely purely on static direct cap valuation to determine the loan amount. And for lenders that use a DCF valuation, the reversion value at the end of their DCF hold period is calculated using a direct cap valuation.

Asset Management

Asset managers regularly use the concepts learned in this course. Beyond the role asset managers play in dispositions (when an owner chooses to sell), asset managers regularly estimate the value of the properties they manage.

So for instance, most real estate private equity funds in the United States perform quarterly valuations of their portfolio. That means, every quarter a direct cap valuation (and possibly DCF valuation) must be performed by asset managers on every property they manage.

In addition to quarterly valuations, most firms perform more complete/in-depth evaluations on an annual basis. These in-depth evaluations are sometimes called "business plans", because beyond valuing the property at that point, the asset manager will develop a budget together with an operating plan for the year. Based on that budget, a direct cap valuation will be performed.

Development

Developers likewise use direct cap valuation in their analysis. Every developer calculates the value of a proposed development at stabilization (after the development is completed and fully leased). A potential development is generally only worth doing when a developer can build a project at a cost sufficiently less than the projected stabilized value. That value at stabilization is calculated using direct cap valuation.

And for developers who build-to-core (i.e. build to own long-term), they also perform a direct cap valuation in their DCF analysis to calculate the reversion value at the end of the hold period.