For valuation of Real state we discount Net Operating income using Capitalization rate. The underlying principle is same as valuation considering FCFF or FCFE.
My question is:
Why do we not consider tax while valuing a real state using NOI, when we do consider tax while using FCFF/FCFE?
It shouldn’t make any difference.
We use the NOI of comparable properties along with their sales prices to determine a cap rate, and then use that cap rate along with the NOI of the subject property to estimate its value.
If we deduct taxes (a fixed percentage of NOI), we’ll end up with the same estimate of value. The NOIs will be different (smaller), but the cap rate will be correspondingly smaller; the net result – the estimate of the value of the subject property – will be the same either way.
I think the best way to understand this is that NOI is an operating income measure, and not a true cash flow measure, thus it can be thought of more like EBITDA rather than FCFF/FCFE. Non-operating expenses such as taxes are typically specific to the owner/investor thus they are excluded from NOI.
As the CFA curriculum states, NOI is a before-tax unlevereaged measure of income.
Thank you for sharing your comments.
Here is my thinking: If I want to invest in a real estate I will value it on basis of future cash flows that the property would bring to me. Assuming the cash flows are from rent, the rent are not taxed before it reaches my pocket and hence there is no need to tax decuct before capitalizing it i.e. discounting with my cost of equity.
The same holds for a REITs where the income are not taxed before reaching my pocket.
Unfortunately the money a firm makes is taxed before reaching the equity holder and hence the tax treatment.