Cost of Capital: Applications and Examples, + Website, 5th Edition

APPENDIX 41A

Valuing Real Estate Entities¹

Introduction

Measuring Net Cash Flow for Real Estate Entities

Projected Cash Flow from Real Estate Operations

Projected Net Cash Flow for Real Estate Entity

Funds from Operations and Adjusted Funds from Operations

INTRODUCTION

Estimating the net cash flow associated with real estate entities is the focus of this appendix. Some real estate entities use their own set of definitions that parallel those used in business valuation. This appendix introduces the reader to the accounting measures that may be encountered in real estate entity valuations.

MEASURING NET CASH FLOW FOR REAL ESTATE ENTITIES

The anticipated financial benefits that come from investing in a real estate entity are no different from any other enterprise. The three sources of these benefits are:

1. Earnings or cash flow (from operations or investments)
2. Liquidation or hypothecation of assets
3. Sale of the interest²

Real estate entities are going concerns engaged in a real estate-related business enterprise. Generally, the value of a going concern has been defined as the value of a business enterprise that is expected to continue to operate into the future. The intangible elements of going-concern value result from factors such as having a trained workforce, an operational plant, and the necessary licenses, systems, and procedures in place.³

The value of a going concern includes the tangible assets as well as the intangible assets.

Most real estate entities prepare consolidated ...