Practice Briefing: The implications of a move towards explicit discounted cash flow (DCF) models for property investment valuations
Journal of Property Investment & Finance
ISSN: 1463-578X
Article publication date: 28 June 2024
Issue publication date: 8 August 2024
Abstract
Purpose
The primary purpose of this Practice Briefing is to examine the implications of the recommendations of the Royal Institution of Chartered Surveyors (RICS) Review of Investment Valuations to shift towards (explicit) discounted cash flow (DCF) valuations on valuers, clients, risk management and market data.
Design/methodology/approach
This Practice Briefing will develop a conceptual framework to articulate the impact of the shift towards explicit modelling assumptions in valuations. A comparative analysis is conducted to contrast traditional valuation approaches with an explicit DCF approach.
Findings
The proposed shift to DCF valuations in the real estate industry carries both subtle and profound implications. While on the surface, the move appears to bring minimal change since current valuations are already DCF-based, a deeper exploration reveals a potential transformation to the understanding, analysis and measurement of pricing and risks in commercial real estate.
Practical implications
The traditional techniques adopted in valuations have become pervasive in the industry, hindering more sophisticated modelling and analysis of individual assets and portfolios. Explicitly modelling assumptions in both the initial years of cash flow and perpetuity calculations would unveil fundamental relationships and rationales that have previously been buried within, and perhaps ignored by, an All Risks Yield (ARY).
Originality/value
This briefing identifies the cause of confusion when interpreting ARY differentials on implied target returns and risk and demonstrates how a change to explicit assumptions, such as growth and letting periods, would enhance transparency, enabling more informed client–valuer discussions, which in-turn will boost confidence in valuation accuracy, lead to more sophisticated asset modelling, market data, forecasting and market analysis.
Keywords
Citation
Frodsham, M. (2024), "Practice Briefing: The implications of a move towards explicit discounted cash flow (DCF) models for property investment valuations", Journal of Property Investment & Finance, Vol. 42 No. 4, pp. 380-395. https://doi.org/10.1108/JPIF-04-2024-0052
Publisher
:Emerald Publishing Limited
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