Why Perpetuity Formula to value Real Estate?

CFA Level II Alternative Investments
#1

Hi

I would like to know why we use formulas of perpetuity to value a real estate property? for example the formula

value = NOI / r - g

assumes that the NOI will grow perpetually when in fact the average life of a property is only 40 to 50 years?

Thanks for your responses

#2

Hi Hassan,

Mathematically you can conclude that the value that you get from perpetuity formula or by annuity formula using 40-50, the answers will be very close. The perpetuity is used as an approximation in valuation as there will be more noise in the estimation when the number of years is very high

#3

Formula what you wrote eventually same as GGM if I assume from your question that NOI is the future (next period) of NOI (in case of GGM will represent D1)

#4

The same conclusion may apply on DCF on DDM while valuing company assuming the most of companies worldwide (especially SMEs) even doesn’t survive more than two decades.

That’s why they invented a Going concern priciple. Likely same kind of going concerns apply on RE with DCF or capitalization approach.