Discounted cash flow (DCF) analysis is a tool used by investors to estimate how much an investment in an asset class such as real estate is worth. This valuation method involves projecting future cash flows, determining the exit value by capitalising income and expenditure at a specified date, and discounting them to their present value. But, while many investors use this method, it's important to look at both the good and bad sides of it when considering its usefulness for market valuations.

‍

A benefit of using DCF analysis is that it can work for all kinds of asset classes, such as income, development, and operational assets. Plus, it enables valuers to scrutinise different property characteristics such as locational, physical, occupational, and environmental factors, leading to a more comprehensive assessment.

‍

For example, if a building doesn't meet minimum Energy Performance Certificate (EPC) standards, using DCF analysis is helpful, because the building would need money spent on it to make it better, which would change how much it's worth in the future. With occupiers increasingly valuing environmentally friendly properties, the level of capex and resulting improvements would influence both the estimated rental value (ERV) and tenant quality, and using a DCF enables the valuer to look at a variety of different scenarios.

‍

But using DCF analysis has its challenges too. It's pretty complicated because it needs lots of information about things like future estimates for values and capex expenditure. This makes it take a long time to do and needs a lot of attention to make sure all the numbers are right.

‍

As discounted cash flows involve many variables, they can be affected by lots of different influences, so, as a valuer, it’s important to always make careful note of why particular assumptions are chosen and back this up, where possible, with comprehensive evidence such as comparables.

‍

So, while DCF analysis is a useful way to figure out how much a real estate investment is worth, it's important to know the good and bad things about it. By being careful about how it's used and considering all the different factors, valuers can provide detailed and comprehensive valuations for real estate assets.

‍

And as investors continue to navigate the real estate world, they'll likely keep using DCF analysis to figure out what investments are worth, so it makes sense that valuers should also be using this method where relevant to value assets for those investors.

‍