1. Principles of Commercial Real Estate Finance
Module 2:
Time Value of Money and
Discounted Cash Flow;
Real Estate Cycles
Associated Readings
Linneman Text:
Prerequisite I: The Basics of Discounted Cash Flow &
Net Present Value Analyses
Ch. 20: Real Estate Cycles
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Resources page, Recommended Viewing section:
“Crisis of Credit” videos
Aqua at Lakeshore East, Condominiums, Chicago
Copyright © 2012 by Real Estate Financial Modeling, LLC. All rights reserved.

2. The Importance of Timing
• Owners generally do not want to spend money before they
absolutely have to.
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• Vendors and service providers generally want to get paid as
soon as possible.
• Investors want to get paid based on the transaction
documents, whose profit‐sharing terms have been
architected based on our investment objectives.
• Internal Rate of Return (IRR) metric depends partly on the
timing of cash flows.
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3. Time Value of Money / Discounted Cash Flow (DCF) Model
• The passage of time introduces the potential for both
positive and negative change in the value of a dollar.
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• It theoretically allows us to invest $1.00 today (Present
Value) and get a positive return on it, so that it would
be worth more than $1.00 in the future (Future Value).
• It also introduces operating, market and credit risks, all
of which could destroy part or all of the value of the
$1.00 we invest.
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4. Time Value Of Money Basics
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Today The
(Time 0) Future
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5. Time Value Of Money Crash Course
• We agree in theory that $100.00 in hand today is
equivalent to a value greater than $100.00 at some point
in the future (say $104.00 at the end of 1 year), under the
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assumption that the amount by which the $100.00 base
amount is grown (4% over 1 year in this case) is the
appropriate growth estimate.
365 days
Today 4.00% Growth End of
(Time 0) Over 1 Year Year 1:
$100.00 $104.00
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6. Time Value Of Money Crash Course
• If we were to theoretically transport ourselves to the end
of Year 1 and look backwards, to get back to the $100.00
amount at Time 0, we would apply the 4.00% growth rate
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in reverse. This is known as discounting the future
expected cash flow.
365 days
Today 4.00% Reverse Growth End of
(Time 0) (Discounting) Over 1 Year Year 1:
$100.00 $104.00
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7. Time Value of Money / Discounted Cash Flow (DCF) Model
Time Value of Money
4% constant growth rate is assumed
Year 1 Year 2
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Today End of Year 1 End of Year 2
$100 $104.00 $108.16
Today End of Year 1 End of Year 2
Future Value of $100 -- $104.00 $108.16
Future Value Derivation -- $100 x (1 + .04) $100 x (1 + .04) x (1 + .04)
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8. Time Value of Money / Discounted Cash Flow (DCF) Model
Time Value of Money
4% constant growth rate is assumed
Year 1 Year 2
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Today End of Year 1 End of Year 2
$100 $104.00 $108.16
Today End of Year 1 End of Year 2
Future Value of $100 -- $104.00 $108.16
Future Value Derivation -- $100 x (1 + .04) $100 x (1 + .04) x (1 + .04)
‐ How certain are we that we will indeed get these exact cash flows?
‐ What is the likelihood that the 4% constant growth assumption is
wrong?
>> Go To Excel: TVM Timeline and Calculator tab
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9. Time Value of Money / Discounted Cash Flow (DCF) Model
• Just like a company listed on the stock market, an
income‐producing property can be valued based on
the expected value of its future cash flows
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• To properly value these expected future cash flows
today, we discount them to a present value based on
all of the aforementioned risks as they apply
specifically to the contemplated transaction
• These future values are first inflated based on
escalation assumptions (Note that income and expense
assumptions are not necessarily identical)
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10. Real Estate Cycles
• Cycles are prolonged periods of property supply and demand
imbalance
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• Real estate markets are rarely near equilibrium because:
• it takes so long to plan, permit, finance, build and lease new
supply
• inventory is relatively imperishable (bulldozing as a remedy)
• tenancies are governed by leases, often long‐term
• demand grows slowly
• population (around 1%, or 3MM people per year in U.S.)
• employment
• On average, 1.8MM jobs created per year
• ~200 GSF required per office employee
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11. The Real Estate Cycle – Generic
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12. The Real Estate Cycle – U.S. Commercial, 1Q2009
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13. The Real Estate Cycle – U.S. Commercial, 2Q2009
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14. The Real Estate Cycle – U.S. Commercial, 3Q2009
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15. The Real Estate Cycle – U.S. Commercial, 4Q2009
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16. The Real Estate Cycle – U.S. Commercial, 1Q2010
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17. The Real Estate Cycle – U.S. Commercial, 2Q2010
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18. The Real Estate Cycle – U.S. Commercial, 3Q2010
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19. The Real Estate Cycle – U.S. Commercial, 4Q2010
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20. The Real Estate Cycle – U.S. Commercial, 1Q2011
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21. The Real Estate Cycle – U.S. Commercial, 2Q2011
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22. The Real Estate Cycle – U.S. Commercial, 3Q2011
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23. The Real Estate Cycle – U.S. Commercial, 4Q2011
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24. U.S. Housing Market Pricing, 1890 ‐ 2006
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Source: Huffington Post
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25. U.S. Housing Market Pricing, 1970 ‐ 2010
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26. Local Housing Market Pricing, 2001 – 2009
• But remember, every market is unique
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Source: New York Times
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27. Submarkets Are Unique, Too
• Georgetown vs. Anacostia
• Capitol Hill vs. U Street
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• Kalorama vs. Rosslyn
• Ballston vs. Mount Vernon Triangle
• Southwest vs. Glover Park
• Silver Spring vs. Tysons Corner
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