Author: Waldo L. Born and Stephen A. Pyhrr

Start Page: 455
End Page: 486
Volume: 9
Issue Number: 4
Year: 1994
Publication: Journal of Real Estate Research

Abstract: Traditional real estate valuation models stabilize cash flow variables in a single- or multi-year pro forma, assume efficient markets, and impute property return/risk expectations into a current overall market capitalization rate to determine value. This traditional valuation framework is biased toward trend analysis and often assumes constant annual changes in rents and expenses and constant terminal value capitalization rates over a seven-to-ten-year projection period. Economic cycles are not explicitly addressed by the valuation framework or models. This study uses a cycle valuation model to evaluate linkages between real estate supply and demand cycles, equilibrium price cycles, inflation cycles, rent rate catch-up cycles, and property life cycles; translates their effects on cash flow variables; and demonstrates their significant impact on asset value. The cycle model results are then compared to those produced from traditional borrower and lender "trend driven" valuation models. The study results suggest that appraisers should develop cash flow models that explicitly incorporate cycle impacts in order to produce realistic present value estimates and valuation conclusions. Further, the market research process must be redefined and reorganized to produce information and data for use in cycle models.