NPV calculations - what is terminal value?

If anyone is doing NPV calculations on parks - how do you set the terminal value or do you just run it 25 or 30 years?

I am used to doing this on oil/gas wells so I’m not sure how to apply to parks.

To do a DCF calculation of real estate you would use a shorter time period than that, typically 5-10 years. While everything taught by MHU utilizes trailing NOI to calculate a value, a more academic way is to approach it would be to apply a terminal cap rate to the year 11 cashflow (read how an appraiser would handle it). A conservative model would using a higher “going-out” cap rate than the “going-in” rate. The theory behind that is, you are dealing with an older asset that has physically depreciated over the holding period. With the low historical cap rate we are seeing across all commercial real estate assets, it is not unreasonable to assume cap rates will be higher in 5-10 years. However, if you have a capital improvement plan that you will account for in the model, a lower terminal rate may be appropriate.

An additional note, if you attend the Boot Camp, they give you a very solid DCF excel model. It is one of the best off the shelf models I have seen for any asset class.

To set the terminal value, I would cap the current year or forward year NOI. MHU teaches cap the in place NOI, so that you do not pay (or provide value for your sale price) for vacant lots. Other areas of real estate, such as office or apartment buildings, cap the forward year NOI to derive sale price.

Proforma a 5 or 10 year model (most appraisers will model 10 years). A general rule of thumb many commercial real estate professionals use is cap rate expansion of 50-100 bps over the hold period. So if the market cap rate is 7.00% today, you might say the market cap rate in 10 years from now will be 7.50% - and this will be your exit cap. This is the part which is more art than science, but to be conservative expand your exit cap. I’ve seen some people expand cap rates 5 bps per year and others will do 10 bps per year.

To fill in the next part of your NPV analysis - figuring out the discount rate. Speak to an appraiser to find out what current discount rates are. Investment sales professionals may be able to assist with this as well as they know where current deals in the market are trading. Alternatively, and technically, the IRR is the discount rate. So if you have an IRR you want to solve for, you can back into your discount rate, and therefore purchase price.

Remember, if you are figuring out an NPV it should be on an unleveraged basis. If you do it on a leveraged basis, the different debt structure for each deal will greatly effect the net present value. If you do this on an unleveraged basis every time, you will begin to see patterns on pricing and where deals trade. The debt is the cherry on top of why you are doing the deal and (hopefully) getting great returns. But calculating NPV on an unleveraged basis allows you to compare deals apples to apples.