How structural differences in income security justify changes in required return.
Learning outcomes
- Understand which risks truly justify a Target Return adjustment
- See why the unexpired lease term, letting periods and covenant strength affect Target Returns
- Learn how shorter leases lead to higher expected return volatility
Description
Worth analysis should reflect the investor’s own risk appetite and portfolio context.
This means the Target Return typically reflects:
- the investor’s overall return objectives,
- their tolerance for systematic market risk,
- their capital structure and cost of capital,
their investment horizon.
Worth analysis should reflect the investor’s own return objectives and portfolio context.
Structural differences in income security—such as shorter unexpired lease terms, weaker covenants, or higher exposure to market timing—can justify adjusting the Target Return. These risks cannot be diversified away and therefore require a higher (or occasionally lower) required return.
The Target Return should therefore be adjusted only when structural differences in income security lead to materially different return volatility from the portfolio baseline.
