How Do Government Co-Financing Incentives Influence Real Estate Purchase Decisions? How Do Such Incentives Affect the Value of Real Estate for Beneficiaries?
In practice, determining the correct discount rate for real estate valuation is a challenging task due to the complex relationship between leverage and the effective tax rate. This relationship is influenced by factors such as depreciation components and the duration of property ownership (when will the property be sold?) (more detailed)
We know that pre-tax cash flows should be discounted at a different rate than after-tax cash flows, but how much lower should the after-tax rate be?
There are two main approaches: First, it is important to determine whether we are dealing with a marginal investment or a non-marginal (intra-marginal) investment. A marginal investment means that you are an ordinary buyer assessing whether the offered property is priced at a fair market value. A non-marginal investment means that you are in a special situation (e.g., benefiting from tax incentives or other advantages).
For a marginal investment, the calculation is relatively straightforward. The market provides observable prices for unleveraged properties and pre-tax return rates, which can be used for discounting.
To analyze a specific situation, below is an investment valuation model that follows these steps:
- Determine the market price of the property and the pre-tax discount rate (e.g., $1 million and 6.04%).
- Adjust for leverage, subtracting the cost of debt and using expected cash flows to find the appropriate after-tax discount rate for equity returns. This rate is calculated for a marginal investor, meaning no special tax benefits apply—in our example, 6.44%.
- Apply this discount rate to evaluate the investment, incorporating the effects of any available tax incentives into the cash flows.
Source:
Commercial Real Estate Analysis and Investments – D. M. Geltner, N. G. Miller, J. Clayton, P. Eichholtz
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