The valuation models developed for financial assets are applicable for real assets as well. Real estate investments comprise the most significant component of real asset investments. For many years, analysts in real estate have used their own variants on valuation models to value real estate. Real estate is too different an asset class, they argue, to be valued with models developed to value publicly traded stocks.
This chapter presents a different point of view: that while real estate and stocks may be different asset classes, the principles of valuation should not differ across the classes. The intrinsic and relative valuation techniques that we used to value stocks should work for real estate as well. That said, there are serious estimation issues to confront that are unique to real estate and that will be dealt with in this chapter.
Real estate and financial assets share several common characteristics: Their value should be determined by the cash flows they generate, the uncertainty associated with these cash flows, and the expected growth in the cash flows. Other things remaining equal, the higher the level and growth in the cash flows, and the lower the risk associated with the cash flows, the greater is the value of the asset.
There are also significant differences between the two classes of assets. There are many who argue that the risk and return models used to evaluate financial assets cannot be used to analyze ...