Get Ready For A New Way To Value Real Estate: Discounted Cashflow

Red Book rules on the way real estate is valued will mean more emphasis on discounted cashflows amidst the hope it could become a global standard.

A consultation exercise is underway with the aim of shedding daylight on the assumptions made about future rental income streams and how they affect value.

The move by the UK-based Royal Institution of Chartered Surveyors is part of a wider programme of proposed changes to valuations in the wake of the pandemic.

DCF is a form of valuation that calculates an investment's value based on the ability to receive a predicted future cashflow. An earlier review published last year looked at analytical aspects of DCF valuation. Now the focus moves to standardised property risk advice.

But severe price fluctuations, of the kind seen during the pandemic, call cashflow projections into doubt. The answer is likely to be improved openness about the assumptions built into DCF valuations.

“These developments highlighted the importance of an increased focus on valuation and ensuring that assumptions made within valuations are explicit,” RICS said in a statement. “Being more explicit regarding the assumptions contained within valuations will help those relying upon them have greater confidence in their accuracy.”

The Red Book is the definitive standard by which chartered surveyors undertake valuation advice. The draft Red Book UK Supplement standard for valuing investment property suggests that valuers should strongly consider the use of DCF when undertaking valuations. 

The consultation also includes proposed new global practice information on DCF valuations. The DCF consultation closes on 12 April.

"As part of its commitment to lead the profession globally, RICS is developing a suite of updates to its professional standards, practice information and training material," RICS Chair of the Valuation Review Implementation Committee Richard Waterhouse said. "Fundamental changes in valuation across the industry have led to greater usage of DCF, and so we feel that these updates should focus on this."

The consultation is part of the implementation of the Pereira Gray Review of real estate investment valuations, commissioned by RICS.