Pros and Cons of Using Perpetuity in Real Estate Valuations

Perpetuity refers to a constant flow of cash that runs into infinity. It is purchased using a huge sum of cash but brings about a flow of cash for a lifetime (Pignataro, 2013). Real estate can be considered as perpetuity since once it is bought it bring a constant cash flow over a lifetime. There are several pros and cons that are associated with using perpetuity in the valuation of real estate. In regard to advantages, the major concern in the use of perpetuity in valuation of real estate is how one can give a finite valuation to an asset that brings an infinite flow of cash. This is, however, possible in view of the fact that the actual value of cash flow keeps depreciating. During the initial years the value is high but as time goes by, it decrees to near zero in the distant future. One can, therefore, determine the value of the real estate property using the infinite series sum.

Secondly, an advantage of using perpetuity is because it makes use of a simple formula in the evaluation of real estate. That is PV=C / R (Pignataro, 2013). Where PV represents the present value of the real estate, C represents the periodic amount of cash flow while R represents the required return.

In terms of cons, using perpetuity in real estate valuation, on the other hand, is the fact that much as the value of the income flow keeps depreciating, it can never come to a zero value (Pignataro, 2013). The final value of the cash flow at infinite time can therefore not be evaluated with certainty. Moreover it does not take into account the fact that one may increase the income with increase in inflation. The effect of inflation may therefore be much less that than what perpetuity in valuation presumes.

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