Comparison of the DCF and German income approach

Abstract

Purpose

The majority of institutional investors in Germany use the German income approach (GIA) while investors abroad prefer the discounted cash flow (DCF). The debate around the two methods has been largely theoretical, lacking large-scale empirical evidence. The paper aims to discuss this issue.

Design/methodology/approach

The analysis consisted of a performance comparison and hedonic regressions based on ordinary least squares. Fitted GIA and DCF values were obtained for all observations in the data set in order to eliminate distortions caused by different property characteristics in the two valuation sub-samples.

Findings

The research hypothesis, stating that the two methods result in statistically identical estimations of value, was rejected. The performance analysis showed that GIA valuations displayed smoother total return performance due to less volatile capital growth in comparison to DCF valuations. Comparing the fitted values obtained from the regressions showed that GIA valuations were on average lower than their DCF counterparts. The difference was small and both methods resulted in very similar fitted values. The difference between fitted values was not constant over time and decreased toward the end of the analysis period.

Practical implications

The research adds empirical arguments to the ongoing debate between GIA and DCF valuations. So far empirical proof has been scarce or one-sided.

Originality/value

This analysis is the first large-scale empirical comparison of the DCF and the GIA within the same market.

Citation

Reinert, J. (2019), "Comparison of the DCF and German income approach", Journal of Property Investment & Finance, Vol. 37 No. 1, pp. 58-71. https://doi.org/10.1108/JPIF-04-2018-0025