Monte Carlo Simulations for Real Estate Valuation

In this paper, we use the adjusted present value methodology with Monte Carlo simulations in a real estate valuation context. Monte Carlo simulations make it possible to incorporate the uncertainty in the components of future cash flows and in the discount rate. We use empirical data to extract information about the probability distributions of the various parameters. In particular, we propose a simple model to compute the appropriate discount rate. We forecast the term structure of interest rates using a Cox Ingersoll Ross (1985) model, and then add a premium that is function of both the real estate market and of selected hedonic characteristics of the buildings. Our empirical results suggest that the central values of our simulations are close to the hedonic values. Not surprisingly, the confidence intervals are found to be most sensitive to the discount rate and the exit cap rate being used.