Valuation of cyclical assets and exit value

Abstract

Purpose

Ordinary direct capitalization is normally considered procyclical in its present form (De Lisle Grissom, 2011); for this reason, an alternative approach to direct capitalization may be useful in the determination of a robust opinion of value. The valuation standards propose an alternative determination of terminal value in the discounted cash flow analysis, recommending that for cyclical assets, the terminal value should consider … “the cyclical nature of the asset and should not be performed in a way that assumes “peak” or “trough” levels of cash flows in perpetuity” (IVS 105 Valuation Approaches and Methods para 50.21 lett e).

Design/methodology/approach

The introduction in International Valuation Standards (IVS) of Cyclical Assets raises several questions for the community of real estate professionals and academicians (IVS, 2022, 105 Valuation Approaches and Methods para 50.09 lett d). Cyclical assets can be defined as property whose value is “influenced by upturn and downturn of the market in a significant way” (d’Amato et al., 2019).

Findings

The paper proposes different solutions to the problem. The determination of the exit value using cyclical capitalization allows for a prudent assessment of the value and may be used either as a valuation procedure or a risk analysis method.

Research limitations/implications

The valuation comparison with the traditional valuation techniques will be based on an iteration of exit value in order to determine the effects of the valuation procedure on the opinion of value.

Practical implications

The implication of the valuation procedure is the introduction of a countercyclical valuation method to determine the exit value in order to reach stable and reliable valuations for income-producing properties.

Social implications

These models may have a social implication, providing valuation for income-producing properties that may deal with the property market cycle in a more efficient way, providing efficient valuation for banks and institutions.

Originality/value

The paper is the first application of such a valuation procedure to the determination of exit value.