Applying the DCF model in China's transitional market.
With a transaction volume of over 400 pieces of land (or more precisely land use rights) between 1988-1993 and an additional 400 pieces between 1994-1995, Shanghai is, beyond doubt, a very active land market even though it may not be operating on a basis similar to a pure capitalist market mechanism.(1) However, because most transactions are conducted through negotiation, it is doubtful whether a developer or an investor can actually obtain reliable market data with which to assess the value of land that they own or are planning to purchase. To prevent losing an important source of revenue for the state, the local authority should reconsider re·con·sid·er
v. re·con·sid·ered, re·con·sid·er·ing, re·con·sid·ers
1. To consider again, especially with intent to alter or modify a previous decision.
2. whether the method of assessing land value reflects the highest and best use principle.
A comparison is made between the factors affecting the current market prices of land charged by the Shanghai government and the appraised land values simulated in the same market environment. ("Market price of land" refers to the price of land that a developer would be asked to pay. It is therefore quite different from the traditional definition of "market land price" in a capitalist society, which defines it as a residual element that depends on the income generated from economic activities carried out on and above land.) Appraised residual land prices are simulated by the discounted cash flow (DCF DCF
See: Discounted Cash Flows ) model, one of the best appraisal techniques to estimate land value in a market where finding reliable market comparables is difficult.(2) However, a number of assumptions need to be made in using the DCF model in this study.
First, market prices of various properties are taken from developers' asking prices in the general real estate market. This means that properties are developed to be sold to foreigners Foreigners
the condition of being an alien.
Law. the seizure of foreign subjects to enforce a claim for justice or other right against their nation.
Rare. , Chinese expatriates, or wealthy local citizens. Transactions are normally conducted in Hong Kong dollars Noun 1. Hong Kong dollar - the basic unit of money in Hong Kong
dollar - the basic monetary unit in many countries; equal to 100 cents . This assumption is made because all the land use rights used in this analysis were sold to joint venture entities with foreign developers as partners. These joint ventures develop primarily external market properties because of the large profit margin they can obtain in this sector compared with the internal property market. Since the secondary market in China overall is not very active, developers' asking prices are almost as good as the market prices. Moreover, because the land sales were conducted in 1992, these property prices are (pre-sale) prices for development that would come to China and Hong Kong's markets in 1994-1995, hence confirming that development takes two and a half years.
The second assumption is that the interest rate on the cost of borrowing is assumed to be 9.5% because most of the development involves investors from Hong Kong Hong Kong (hŏng kŏng), Mandarin Xianggang, special administrative region of China, formerly a British crown colony (2005 est. pop. 6,899,000), land area 422 sq mi (1,092 sq km), adjacent to Guangdong prov. . While the prime interest rate in Hong Kong was about 6.5% (the standard mortgage rate is 6.5% + 1.75% = 8.25%) during the test period, a higher interest rate of 9.5% is assumed for the risk involved in China's projects.
Third, the discount rate is fixed at 15% to reflect the risky nature of the projects, as well as the relatively high inflation in China's major cities. This is different from the borrowing rate in that the discount rate reflects the riskiness of both cash inflows and outflows.
Fourth, the developer's profit is set at 30% on the gross development value (GDV GDV
gastric dilatation/volvulus. ) or total sales proceeds of the project, or 45% on total development costs. This is set in consultation with professional firms in Hong Kong. Moreover, this is regarded as reasonable at that period although the profit ratio has, in fact, been dropping.
Fifth, construction costs are total construction costs, including all materials and labor costs. This figure is estimated by a property consultant in Hong Kong to be at least H.K. $350 per square foot, or about U.S. $500 per square meter Noun 1. square meter - a centare is 1/100th of an are
centare, square metre
area unit, square measure - a system of units used to measure areas .(3) (Note that 1 square meter is equivalent to 10.76 square feet.) This figure also coincides with the official indication of building costs between U.S. $373 per square meter to U.S. $585 per square meter for high-rent or luxury residential housing in Shanghai.(4) Consequently, an average of U.S. $520 per square meter is applied for residential development, and U.S. $550 per square meter for mixed-use development Mixed-use development refers to the practice of allowing more than one type of use in a building or set of buildings. In planning zone terms, this can mean some combination of residential, commercial, industrial, office, institutional, or other land uses. projects in 1992, and U.S. $550 per square meter for residential and U.S. $600 per square meter for mixed-use projects in 1993.
Sixth, professional fees reflect the fact that most Hong Kong developers employ their own architects and cost engineers from Hong Kong. However, the fees do not apply to costs for projects in China. As a lump sum Lump sum
A large one-time payment of money. , the construction costs are fixed at 5% for all projects.
Seventh, a special column of taxation is added in accordance with Article 48 of the Regulations on the Transfer of Land Use Rights for Valuable Consideration in Shanghai.(5) According to according to
1. As stated or indicated by; on the authority of: according to historians.
2. In keeping with: according to instructions.
3. this article, a tax of 3% on GDV is levied when the development comes on the market.
Eighth, an agency fee of 1.5% on the GDV can be exacted at the point of sale. Ninth, the local authority would levy a 33% profit tax on the development profit at the completion of the development. Finally, although the cash payment pattern varies with projects, standardizing the DCF models in the simulation process is necessary. Hence, all construction costs are assumed to be payable quarterly while bank interests on costs are payable half-yearly.
Based on these assumptions, 180 pieces of land sold in Shanghai from 1992-1993 are then reappraised while the actual market prices of these lots are recorded from government publications. These land prices are computed in the format of accommodation value, or AV format, which is basically land price divided by the gross floor area of the development. This is so that the use of the [TABULAR tab·u·lar
1. Having a plane surface; flat.
2. Organized as a table or list.
3. Calculated by means of a table.
resembling a table. DATA FOR TABLE 1 OMITTED] [TABULAR DATA FOR TABLE 2 OMITTED] unit land price based on per square foot of floor area is consistent.(6) The DCF model applied in the simulation process (see table 1).
To test the validity of the appraisal model of land from which land values are simulated in Shanghai, appraisers need to look at the objectivity of the DCF model. A sensitivity analysis can identify and examine the factors in the model that have the greatest effect on the assumptions used here. Table 2 shows the means and standard deviations In statistics, the average amount a number varies from the average number in a series of numbers.
(statistics) standard deviation - (SD) A measure of the range of values in a set of numbers. of the changes in the appraised land values according to changes in the major assumptions.
In the sensitivity analysis, the value of one of the major assumptions is changed while the rest of the variables are kept constant. The resulting effects on the appraised land values are then recorded. When the most sensitive variables are identified, new sets of residual land values are compiled and the regression analysis In statistics, a mathematical method of modeling the relationships among three or more variables. It is used to predict the value of one variable given the values of the others. For example, a model might estimate sales based on age and gender. is applied to them again. If the results are similar to the results of the original assumptions, then the DCF model is sound.
In deciding whether land values simulated by the DCF model represent a proxy for the highest and best use basis of land values in Shanghai, appraisers should check whether the appraised land values correlate better with Shanghai's market environment than the market price of land. Two sets of multiple regression Multiple regression
The estimated relationship between a dependent variable and more than one explanatory variable. analysis accomplish this.
Multiple analysis has been widely used in estimating the relationship between environmental factors and real estate prices.(7) The regression analysis applied is not intended to show the prediction power of the DCF model over the actual market prices of land, although it could be applied in this way. The purpose of the analysis is to show that it is reasonable to assume that the market environment in Shanghai generates land prices close to the DCF model's theoretical land values. This model's dependent and predictor variables Noun 1. predictor variable - a variable that can be used to predict the value of another variable (as in statistical regression)
variable quantity, variable - a quantity that can assume any of a set of values are defined in the following:
Market land value:
AV = Market land value for land use rights/Gross floor area allowed on site
RAV = Residual land price for land use rights/Gross floor area allowed on site
AV is the actual market price of land in accommodation format and RAV is the appraised land values in accommodation value format.
Ten predictor variables were identified and drawn from similar research studies. They are as follows:
1. The first predictor variable, Comland used for commercial purposes, is derived from a survey conducted by the Planning Science & Technology Office of the Shanghai Land Administration Bureau in 1992. It shows the amount of land in each of 10 urban districts.(8) Including this variable in the regression analysis makes it possible to examine the effect of the old land use pattern created under the planned allocation of land, a decision developers made under the land use rights reform.
2. The second, Employ, shows the increase between 1991 and 1992 in the number of people employed in private enterprises in the urban districts in which the sites are located. This variable relates to the local economy (district by district) in terms of private enterprises being market oriented o·ri·ent
1. Orient The countries of Asia, especially of eastern Asia.
a. The luster characteristic of a pearl of high quality.
b. A pearl having exceptional luster.
3. . The higher the number of people employed in private enterprises in a particular district, the higher the demand for premises by these enterprises and their employees.
3. Grade represents the land grade as classified by Shanghai's city government within an urban district. Five grades of land are applied to the entire urban Shanghai municipality MUNICIPALITY. The body of officers, taken collectively, belonging to a city, who are appointed to manage its affairs and defend its interests. . To avoid possible distortion (such as two choices available for one dummy variable This article is not about "dummy variables" as that term is usually understood in mathematics. See free variables and bound variables.
In regression analysis, a dummy variable ), five dummy variables are used instead of just one variable for the predictor "land grade".(9) Hence, there are grades 1, 2, 3, 4, and 5. When a particular site is on grade 3 land, the variable for grade 3 is 1, and the variables are all Os.
4. Hirise represents the quantity of high-rise buildings high-rise building
Multistory building taller than the maximum height people are willing to walk up, thus requiring vertical mechanical transportation. The introduction of safe passenger elevators made practical the erection of buildings more than four or five stories tall. (those buildings over 20 floors) in terms of gross floor area (GFA GFA Gospel for Asia
GFA Guitar Foundation of America (Garden Grove, CA)
GFA Ghana Football Association
GFA Gross Floor Area
GFA Gliding Federation of Australia
GFA Gateway Foreign Agent
GFA Gas Forced Air ) out of the total built-up GFA in an urban district. This variable makes it possible to examine how the density of the developments affect land price in a particular district.
5. Indland represents the quantity in each of 10 urban districts. It was developed for industrial use by the Planning Science & Technology Office of the Shanghai Land Administration Bureau in 1992. The inclusion of this variable in the regression analysis makes it possible to examine the effect of the old land use pattern created under the planned allocation of land, a decision developers made under the land use rights reform.(10)
6. Popden represents the population density per square kilometer kilometer
one thousand (103) meters; 3280.83 feet; five-eighths of a mile; abbreviated km. in the respective urban district in which the site is located.
7. Because of the relatively short study period of land price behavior, the 1992-1993 land sale program in Shanghai is divided into four half-yearly subperiods (T1, T2, T3, and T4). This method shows the effect of time on land prices in Shanghai.
8. Size is the size of the site in square meters.
9. A dummy variable is used for Use Type 1. It represents mixed-office and upscale residential buildings, projects that attract foreign developers and investors.
10. Distance in kilometers of the site from the Bund (a riverbank along the Huangpu River The Huangpu River (Simplified Chinese: 黄浦江; Traditional Chinese: 黃浦江; Pinyin: Huángpŭ Jiāng and once the central business district of Shanghai) where a financial street will be redeveloped.
In addition, it should be noted that in the 1992 land use survey of Shanghai's Land Administration Bureau, at least 10 different land uses were classified in the survey, but only those with substantial effects on land prices were selected for the regression model. Originally, the percentage of residential land was also selected for the model, but was eliminated because it correlated cor·re·late
v. cor·re·lat·ed, cor·re·lat·ing, cor·re·lates
1. To put or bring into causal, complementary, parallel, or reciprocal relation.
2. very closely with another predictor variable, population density. This multicollinearity effect, i.e., the correlation effect that results from the interrelationship in·ter·re·late
tr. & intr.v. in·ter·re·lat·ed, in·ter·re·lat·ing, in·ter·re·lates
To place in or come into mutual relationship.
in between two between predictor variables, is undesirable.
Moreover, in the different types of development to be put on sites, only the Use Type 1, or the mixed-office/high-rent residential development is included as a dummy variable. The reason for this is to establish the highest and best use of land which, given the current market, is office and upscale residential.
Finally, the test results show that a relatively higher adjusted [R.sup.2] (0.65) is obtained in the regression analysis of the appraised land values compared with a low adjusted [R.sup.2] (0.30) in the market prices of land. The function of the adjusted [R.sup.2] is to show the degree that the predictor variables can explain the appraised land values. In this case, about 65% of the determination of the appraised land values can be explained by the predictor variables chosen in the analysis. Generally, the higher the adjusted [R.sup.2], the more useful the predictor variables and vice versa VICE VERSA. On the contrary; on opposite sides. . It is, therefore, apparent from the test that the market in Shanghai relates more to the hypothetical Hypothetical is an adjective, meaning of or pertaining to a hypothesis. See:
The sensitivity analysis already examined shows that three components in the DCF appraisal model are influential in determining appraised land values: sales prices of the development, construction costs, and developer's expected rate of profit. Systematic changes to these three components are made one by one, and the resulting appraised land values are recorded. These new appraised land values under the new assumptions are then regressed and the new test results compared with those obtained before. Table 3 summarizes the effects of these changes in assumptions.
For a 50% fluctuation Fluctuation
A price or interest rate change. in both directions in any of the major components in this DCF model for appraising the residual land value, consistent regression results are obtained from and support the conclusion drawn in a later section. The only exception to this observation is a 50% drop in property prices - rather unusual in a growing property market such as Shanghai, in which international companies have substantial interests.(11)
As a result, it is quite reasonable to state that the standardized standardized
pertaining to data that have been submitted to standardization procedures.
standardized morbidity rate
see morbidity rate.
standardized mortality rate
see mortality rate. assumptions applied in the DCF model are realistic and the appraisal model can estimate land values that could have been realized if the market mechanism had been a more competitive one.
In addition, table 4 shows that the level of market prices of land charged by the city government in Shanghai is much lower than the appraised land values. With the promising economic growth of this Chinese metropolitan city and the substantial growth in real estate values in the past few years as well as the future,(12) it is reasonable to say that the DCF model's land values do represent the market value of land use rights in Shanghai.
As with other financial analytical techniques An analytical technique is a method that is used to determine the concentration of a chemical compound or chemical element. There are a wide variety of techniques used for analysis, from simple weighing (gravimetric) to titrations (titrimetric)to very advanced techniques using , the DCF model is not without drawbacks. The relationship of risk as it applies to the discount rate as opposed to the capitalization rate Capitalization Rate
According to the Appraisal Institute, it is a method used to convert an estimate of a single year's income expectancy into an indication of value in one direct step, by dividing the income estimate by an appropriate rate. in the DCF model,(13) must be considered, along [TABULAR DATA FOR TABLE 3 OMITTED] [TABULAR DATA FOR TABLE 4 OMITTED] with the lack of substantial proof that the use of the DCF model actually improves an investor's performance,(14) and the reasonableness in setting the various assumptions in the DCF model.(15) However, this model remains a robust analytical tool for assessing the value of land in a market where limited information is available and where land prices are distorted because of the immature immature /im·ma·ture/ (im?ah-chldbomacr´) unripe or not fully developed.
Not fully grown or developed.
unripe or not fully developed. market mechanism of China's transitional economy.
A more open and competitive mechanism to price land use rights is needed to achieve market land prices close to those obtained in the DCF model. These market land prices are more closely correlated to the current market in Shanghai and are higher than the actual prices of land currently charged. While it is this article's objective to speculate the purposes of the current land pricing mechanism in Shanghai, when a secondary market of land is gradually developed among private developers later on, it will become possible to estimate market land prices using the DCF model.
This study provides a framework for analyzing the reliability of existing market data by comparing it with a set of hypothetical appraisal values The appraisal value is the value of a company based on a projection of future cashflows that its owners will receive from the company's assets as well as from its current and future operations. . The appraisal values are a sort of audit system for estimating land prices in a new and emerging real estate market. Normally, in a developed real estate market, appraisal data does not provide this function since market prices reflect highest and best use. But when the market itself, though very active, does not function efficiently, the appraisal data obtained from the DCF model may provide a reference point for both the state and investors.
1. Ling ling: see cod. Hin Li, Privatization privatization: see nationalization.
Transfer of government services or assets to the private sector. State-owned assets may be sold to private owners, or statutory restrictions on competition between privately and publicly owned of Urban Land in Shanghai (Hong Kong: Hong Kong University Press, 1996), 44-58.
2. B. R. Weber, "Market Value Without a Market," The Appraisal Journal (October 1990): 523-532; T. V. Grissom, "Appraisal Models and the Feasibility Process," The Appraisal Journal (April 1986): 214-224; and T. J. Keith, "Applying Discounted Cash Flow Analyses to Land in Transition," The Appraisal Journal (October 1991): 458-470.
3. Review Publishing Company, Ltd., "And Now for China," Far East Economic Review (December 1992): 59-60.
4. Office of the Shanghai Municipal Committee for Land Use System Reform/Municipal Statistical Bureau of Shanghai, Shanghai Real Estate Market '93 (Shanghai: China Statistical Publishing House, 1993), tables 4-10-1 and 4-10-2.
5. Regulations on the Transfer of Land Use Rights for Valuable Consideration in Shanghai, promulgated prom·ul·gate
tr.v. prom·ul·gat·ed, prom·ul·gat·ing, prom·ul·gates
1. To make known (a decree, for example) by public declaration; announce officially. See Synonyms at announce.
2. on November 29, 1987, by the Shanghai Municipal People's Government.
6. G. D. Jud, "The Effects of Zoning on Single-Family Residential Property Values: Charlotte, North Carolina “Charlotte” redirects here. For other uses, see Charlotte (disambiguation).
Charlotte is the largest city in the state of North Carolina and the 20th largest city in the United States. ," Land Economics (May 1980): 142-154.
7. Maurice H. Yeates, "Some Factors Affecting the Spatial Distribution of Chicago Land Values, 1910-60," Economic Geography (1965): 57-70; David M. Grether and Peter Mieszkowski, "Determinants of Real Estate Values," Journal of Urban Economics (1974): 127-146; Michael S. Johnson and Ward R. Ragas, "CBD (Component Based Development) Building applications with components (objects). See component software.
CBD - component based development Land Values and Multiple Externalities externalities
side-effects, either harmful or beneficial, borne by those not directly involved in the production of a commodity. ," Land Economics (November 1987): 337-347; Richard B. Peiser, "The Determinants of Nonresidential Urban Land Values," Journal of Urban Economics (1987): 340-360; Chien Han et al., Analysis of the Changes in Urban Land Prices in Taiwan (Taipei, Taiwan: National Science Committee, 1992), 40-61.
8. Planning Science & Technology Office of the Shanghai Land Administration Bureau, Report on Land Use Survey (Shanghai, China: Planning Science & Technology Office of the Shanghai Land Administration Bureau, 1992), 18-35.
9. Richard F. Gunst and Robert L. Mason, Regression Analysis and Its Application (New York New York, state, United States
New York, Middle Atlantic state of the United States. It is bordered by Vermont, Massachusetts, Connecticut, and the Atlantic Ocean (E), New Jersey and Pennsylvania (S), Lakes Erie and Ontario and the Canadian province of , New York: Marcel Dekker Marcel Dekker is a well-known encyclopedia publishing company with editorial boards found in New York, New York. They are part of the Taylor and Francis publishing group.
Initially a textbook publisher, they went to encyclopedia publishing in the late 1990's. , Inc., 1980), Chapter 3.
10. Report on Land Use Survey, 7, 12,19.
11. Anthony Walker, Kwong-Wing Chau, and Wai-Chung Lai, Hong Kong in China: Real Estate in the Economy (Hong Kong: Brooke Hillier Hillier is a surname, and may refer to:
12. Privatization of Urban Land in Shanghai, 94-113.
13. Martin A. Skolnik, "Comments on Discounted Cash Flow Analysis," The Appraisal Journal (July 1993): 394-398.
14. W. B. Martin, "Direct Capitalization capitalization n. 1) the act of counting anticipated earnings and expenses as capital assets (property, equipment, fixtures) for accounting purposes. 2) the amount of anticipated net earnings which hypothetically can be used for conversion into capital assets. or Discounted Cash Flow Analysis?," The Appraisal Journal (July 1993): 390-393.
15. Mackenzie S Mackenzie, river, c.1,120 mi (1,800 km) long, issuing from Great Slave Lake, Northwest Territories, Canada, and flowing generally NW to the Arctic Ocean through a great delta. Between Great Slave Lake and Lake Athabasca it is known as the Slave River. . Bottum, "Discounted Cash Flow Analysts: Tests of Reasonableness," The Appraisal Journal (January 1993): 138-143.
Li, Ling Hin. "The Official Land Value Appraisal System Under the Land Use Rights Reforms in China," The Appraisal Journal (January 1995): 102-110.
Needham, B. "A Theory of Land Prices When Land Is Supplied Publicly: The Case of the Netherlands," Urban Studies (1992): 669-686.
Walker, Anthony, and Ling Hin Li. "Land Use Rights Reform and the Real Estate Market in China," Journal of Real Estate Literature (1994): 199-211.
Ling Hin Li, PhD, is an assistant professor of real estate economics at the University of Hong Kong The University of Hong Kong (commonly abbreviated as HKU, pronounced as "Hong Kong U") is the oldest tertiary institution in Hong Kong. Its motto is "Sapientia et Virtus" in Latin, and " . He received his BSc in land management from the University of Reading in England, and his PhD in real estate from the University of Hong Kong. His work has appeared in many real estate journals published in the United States United States, officially United States of America, republic (2005 est. pop. 295,734,000), 3,539,227 sq mi (9,166,598 sq km), North America. The United States is the world's third largest country in population and the fourth largest country in area. and abroad. Contact: Dept. of Real Estate and Construction; University of Hong Kong; 5/F Knowles Building; Pokfulam Road; Hong Kong. 011-852-2859-2146. Fax 011-852-2559-9457, Email email@example.com.