The discounted cash flow (DCF) research is a valuation methodology for estimating an investment’s value based on the concept of discounting, which relies on the
time value of money. This analysis aims to establish an investment’s value on present day depending on the estimates of the amount of money it will create in the future. Property management and development is by nature, uncertain. Owing to this, a forecast of the performance levels of any property investment market is full of uncertainties which can result to serious financial fallouts for the developers.
The Australian property market as of October 2019 had seen an increase of 10.9% as from 2016. This figure represents Australia’s property investment market among the fastest growing economies worldwide. The prices of property in Sydney and Melbourne were at the peak records and the prices were termed as exorbitant and went beyond the buying power of many buyers. Subsequently, national living prices increased by 19% while the house remunerations increased by 9.2% as from the estimation from the ANU Centre for Social Research and Methods. The national household price to remuneration ratio as at September 2016 was 6.9 times, translating to 7.2% for households and 6.4% for units as recorded a decade ago.36.8% house renumeration was a requirement for one to obtain an 80% loan value mortgage as at September 2001.
The Australian property investors are constantly facing insecurities on decision making in regards to property investment projects from the inevitable high and low seasons. Hence, the investment projects are instituted based on unknown outcomes. This challenge is solved by the discounted cash flow methodology (DCF) which relies on adjustment and discount rates to reveal uncertainties in financial feasibility assessment. Its inability to integrate a wide range of values for solving these uncertainties directly affects property decision making. Hence, DCF depends on certain inputs to give results. It is a popular method used in Australia for evaluating financial feasibility of property investments.
DCF analysis calculates the day figures of estimated future cash flows by integrating a discounted rate. If the value calculated is more than that of the primary investment, the investment should be considered. Australian investors have adopted this method to determine whether a property investment will be profitable.
To conduct a CDF survey, an investor makes an estimation about the desired cash flows in the future and the end value of a property. He/she must also come up with an appropriate discount rate and this depends on the particular investment under consideration. If the project is heavily compounded or the investor fails to obtain future cash flows DCF will not help and a substitutional method can be used.
The DCF formula is expressed as:
DCF = CF1/(1+r)1 + CF2/(1+r)2 + CFn/(1+r)n
Where
- CF = represents one financial year’s cash flow. CF1 represents first year, CF2 represents second year while CFn represents any other extra year
- r = any discount rate applied.
Melbourne Realtors, an Australian property firm wants to examine whether it should invest in a new structure in the outskirts of the city. Weighted average cost of capital (WACC) is the applied deducted amount applicable when finding the value of discounted cash flow. WACC integrates the standard return rate the investors are anticipating in a given financial year. Assuming the firm’s WACC is 5%, this will also be used as the discount rate. Our initial cost of investment is 11million dollars and this project will run five years with yearly estimated cash flows. By summing up all applied discounted amount, one gets the opening cost of the whole project. Subtracting this further by the opening cost we find the net present value.
The major drawback of DCF is the fact that it calls for the need to make assumptions. It requires an investor to make an accurate estimation of the future cash flows for a project. This amount would rely on a number of factors like economic levels, unexpected obstacles and market demand. Estimating too high figures could make an investor chose an investment that may not be profitable in the future. On the other hand, estimating low figures would make an investment appear too expensive, resulting in overlooked opportunities. The discount rate being an assumption requires to be accurately approximated for the model to work.
Despite the financial feasibility potential derived from CDF, the concept has not been widely adopted by property investors in Australia. The slow adoption is due to factors which includes lack of support for these project methodologies. Also, practitioners managing the Australian property investments are yet to comprehend the advantages of valuing embedded flexibility
Current assessment initiatives on Australian property investment market are considered insufficient due to the fact that the assessment heavily relies on domestic factors like economic status of the country and market demand. With globalization and modern advancement in technology, many favorable factors are quickly acted upon by leading global property investors in Australia.
