Discounted Cash Flow on a Saudi Property: A Five-Year Worked Example

A full discounted cash flow on a Saudi income asset, from the first year of net operating income to the discounted exit, with the result tested against a required return.

A discounted cash flow values an asset as the sum of the cash it produces during your ownership plus the cash it produces when you sell, each converted back to today using a required rate of return. It is the only method that forces you to state a holding period, a growth assumption and an exit view explicitly. The example below is illustrative and works the method end to end on a Saudi income building.

The situation

An investor is considering a let commercial building priced at SAR 12,000,000 and intends to hold it for five years before selling. They want to know whether the asset clears a required return of 10 per cent, and if not, what return it does offer at that price.

Assumptions (illustrative)

• Purchase price SAR 12,000,000, with acquisition costs assumed at SAR 840,000.
• Net operating income in year one assumed at SAR 840,000, growing 3 per cent each year.
• Holding period of five years, with the sale taking place at the end of year five.
• Exit capitalisation rate assumed at 7.5 per cent applied to year six net operating income.
• Selling costs assumed at 2.5 per cent of the gross sale price.
• Required return, used as the discount rate, assumed at 10 per cent, with no debt in this case.

Step 1: Build the income series

Year one SAR 840,000. Year two SAR 865,200. Year three SAR 891,156. Year four SAR 917,891. Year five SAR 945,427. Year six, used only for the exit, SAR 973,790.

Each year is the previous year grown by 3 per cent. The sixth year never reaches you as income but it matters more than any of the others, because the buyer at exit is purchasing that income rather than the year you are leaving behind.

Step 2: Set the gross exit value

SAR 973,790 divided by 0.075 equals SAR 12,983,867.

The exit value is forward income capitalised at an assumed rate. Choosing 7.5 per cent when the entry yield on price was 7.0 per cent assumes the market prices the asset slightly less generously in five years, which is a deliberately cautious position rather than a forecast.

Step 3: Deduct the cost of selling

2.5 per cent of SAR 12,983,867 equals SAR 324,597, leaving a net exit of SAR 12,659,270.

Agency, legal and marketing costs on exit are routinely left out of models, and they come straight off the largest single number in the calculation. Any transaction tax applicable on the sale is a separate matter to confirm with ZATCA.

Step 4: Discount the income years

At 10 per cent: SAR 763,636 plus SAR 715,041 plus SAR 669,539 plus SAR 626,932 plus SAR 587,036, giving about SAR 3,362,184.

Five years of income, worth SAR 4,459,674 in nominal terms, are worth about SAR 3,362,184 today at a 10 per cent requirement. The discounting takes roughly a quarter of the nominal income, and the effect grows with every additional year of hold.

Step 5: Discount the exit

SAR 12,659,270 divided by 1.61051 equals about SAR 7,860,412.

The discounted exit is more than twice the discounted income across the whole hold. That ratio is the single most important fact in most income asset models, and it is why the exit assumption deserves more scrutiny than any line in the operating statement.

Step 6: Total the present value and compare with capital

SAR 3,362,184 plus SAR 7,860,412 equals about SAR 11,222,596. Capital committed is SAR 12,000,000 plus SAR 840,000, which is SAR 12,840,000.

The present value is about SAR 1,617,400 below the capital required, so the net present value at a 10 per cent requirement is negative. At this price, on these assumptions, the deal does not clear the hurdle.

Step 7: Find the return the deal actually offers

Repeating the calculation at 7 per cent gives a present value of about SAR 12,668,000, still slightly below SAR 12,840,000. The rate at which present value equals capital committed is close to 6.9 per cent.

The asset offers roughly 6.9 per cent unlevered on these assumptions. That is the honest answer: not that the deal is bad, but that it is priced for an investor whose requirement is near 7 per cent rather than 10 per cent.

What changes the answer

• An exit capitalisation rate of 8.5 per cent rather than 7.5 per cent reduces the gross exit to about SAR 11,456,353 and cuts the discounted total by roughly SAR 925,000.
• Income growth of 1 per cent rather than 3 per cent reduces year six income to about SAR 882,857 and the gross exit to about SAR 11,771,427.
• Acquisition costs of SAR 1,080,000 rather than SAR 840,000 raise the capital required and reduce the implied return by roughly a fifth of a percentage point.
• Extending the hold to ten years increases the weight of income relative to the exit, but also pushes the exit assumption further into territory nobody can evidence.
• A single year of occupancy at 80 per cent rather than full would remove a meaningful share of one year of income and, if it falls in year five, would also depress the income the buyer capitalises.

What the numbers tell you

• The exit usually carries more present value than the whole income stream, so it deserves the most testing.
• A discounted cash flow does not tell you whether a deal is good, it tells you what return a price implies against your own requirement.
• Selling costs and the forward year of income are the two lines most often missing from an exit calculation.
• Comparing the implied return against your requirement is more useful than arguing about whether the assumptions are right.
• If the deal only clears your hurdle at the most generous exit yield you can imagine, you are buying a market view rather than a building.

Limits of this example

Every figure above is an illustrative assumption used to show the method, not a quote, valuation or market rate. Costs, rates, fees and regulations change and must be confirmed with the relevant authority, lender or supplier before you commit.

Domira builds the numbers on a Saudi property with you before you commit: rent and cost evidence, condition and capital expenditure, the appraisal and the sensitivities that decide whether the deal survives a bad year. The investment decision stays yours, and so does the advice of your licensed tax and legal advisers.