Practice Briefing: Explicit discounted cash flow models (DCF) part II – the distinction between worth and market value

Purpose The purpose of this briefing is to discuss the implications of the Royal Institution of Chartered Surveyors (RICS) Independent Review of Investment Valuations, which recommended a shift towards (explicit) discounted cash flow (DCF) valuations for the valuation of investment properties. Part I discussed the background to the review and Part II discusses the implementation and adoption of the recommendations. Design/methodology/approach This briefing discusses the reason for the review and the impact of the recommendations related to a shift towards explicit DCF valuations. A comparative analysis is conducted to contrast implicit valuation models with an explicit DCF model. This has been promoted by the RICS with the publication, in 2023, of the RICS (Global) Practice Information – Discounted Cash Flow valuations. Findings The proposed shift to DCF valuations in the real estate industry carries both subtle and direct implications. This briefing will discuss the likely development of a market consensus for an agreed framework and structure of DCF modelling and the need for transparency when determining and reporting the assumptions underpinning the market valuation. Practical implications Implicit valuation models are widely adopted in property valuations as they capture, through the capitalisation rate determined, market sentiment and expectations that underpin the market valuation. There are issues with the opaqueness of this model and this briefing examines whether a move towards explicit modelling, which by definition makes explicit the assumptions used in the valuation, will help the investment better understand the concept of market value and its relationship to the (individual) worth of the property asset in question. Originality/value This briefing identifies the distinction between market value and the investor’s own calculation of the worth of the asset to themselves based on their own forecasts of market growth and capital value changes. It proffers that a move towards DCF modelling will allow investors to better identify the market expectation assumptions within the valuation model and better compare them, and the Market value, to their own forecasts and worth calculation.