Real Estate Valuation Models: Lender and Equity Investor Criteria

The use of valuation models that focus on lender criteria has been growing in the appraisal field. In the rush to build lender criteria into real estate valuation models, equity investor criteria, expectations, and requirements occasionally have been ignored. The specific criteria considered in this paper are the loan‐to‐value ratio and the debt coverage ratio for lenders and the equity dividend rate for equity investors. Each of these three criteria may be a binding constraint on value. Graphical analysis provides a framework within which major real estate valuation models (i.e., Ellwood, McLaughlin, Gettel, Lusht‐Zerbst, and Steele) are compared. A new valuation model (i.e., the Cannaday‐Colwell model) is developed which utilizes the equity dividend rate. The three definitional models (i.e., McLaughlin, Gettel, and Steele) are found to be relevant only by mere coincidence. Each of these models simultaneously considers two of the three key criteria, completely eliminating the possibility of consideration of anything else; i.e., the models become tautological. It is shown that the discounted cash flow based models (i.e., Ellwood, Lusht‐Zerbst, and Cannaday‐Colwell) each tell one‐third of the story. One of these models will be relevant depending upon whether the binding constraint is the maximum loan‐to‐value ratio, the minimum debt coverage ratio, or the minimum equity dividend rate. The relevant model is the one that yields the lowest value estimate of the three.