Wealth Opportunities in Commercial Real Estate: Management, Financing, and Marketing of Investment Properties

Reversion

When a real estate asset is purchased, what assumption does the buyer, Steven Stable, make as to how long he is going to hold title to the property? The reversion is the amount of monies received by the owner when the real estate is sold or, for the purposes of evaluating a property's value, the amount of money it is anticipated that the owner would receive if the property were sold. How long should the holding period be? It depends on for whom and for what purpose you are evaluating the property, but usually a 10-year holding period is assumed. The discounted cash flow adds the sum of the present value of the first 10 years NOI and then uses the eleventh year NOI to determine the reversion value. In determining the reversion you are asking the question, what would a buyer pay for the property at the beginning of the eleventh year? Theoretically, it would make sense to do another discounted cash flow model starting in the eleventh year, yet given the uncertainty of these projections, it is far easier and seemingly just as accurate to cap the eleventh-year cash flow.

In order to determine the sales price, the eleventh-year NOI is divided by a capitalization rate. This capitalization rate is usually referred to as the terminal capitalization rate or the “going-out” capitalization rate. In contrast, if the first year's income is being capped, then the percentage is referred to as the “going-in” capitalization rate or, simply, the capitalization rate (Cap Rate). It is common ...