Table of contents

Like the capitalisation method, DCF valuation is one of the so-called ‘income’ methods. Its use requires a greater number of parameters to be introduced into the model, making it more complex but also more refined.

Under this method, the cash flows received from the asset must be detailed year by year within the chosen valuation horizon. An exit value is then assigned to the asset when it is sold.

The valuation result is therefore the sum of the discounted cash flows and the discounted cash value.

Cash flow

The level of detail in the cash flow depends on the requirements of the expert and the data available. A simplistic cash flow will include at least the main income and expenditure relating to the asset below.

Rents

The main income from the property is the rent paid by its tenants. Apart from the basic rent (or face rent), it is important to know how to model these different forms of rent:

  • Variable rent. This is often used in the retail sector to link the landlord’s return to the profitability of the shops occupying the premises.
  • Grace period. During this period, the tenant pays no rent. This lack of revenue is often compensated for by a rent increase later in the lease (for example, by a variable rent).
  • Levels. A level is the period during which the tenant pays a specific rent. A tenancy agreement may provide for several escalations (usually at the beginning of the lease).

In a valuation model, it is essential to include the rent indexation parameter. In general, the indexation rate follows the evolution of the appropriate indices for its use: Indice du Coût de la Construction (ICC) for shops, Indice de Référence des Loyers (IRL) for housing, etc.

Charges, taxes and works

The experts make a distinction between these different types of expenditure:

  • Recurring and non-recurring. Recurring expenses are paid on a regular basis (e.g. various taxes), whereas non-recurring amounts are spent on a one-off basis (e.g. expenses relating to asset maintenance).
  • Recoverable and non-recoverable. Some of the charges paid by the landlord are often rebilled to the tenant (e.g. office tax). In valuation models, these are generally defined by a recovery rate. The non-recoverable part therefore corresponds to the expenses that cannot be recovered. The owner will take full responsibility for them.
  • Depreciable and non-depreciable. Depreciable works (Capex) are often linked to the renovation or reconstruction of a building. These costs are amortised during and beyond the business plan period.

Expenditure evolves over the valuation horizon and most often follows the rate of inflation.

So we have defined the main cash flows. All we need to do now is add them up and discount them period by period.

Exit value

There are two main methods of estimating the exit value of an asset: capitalisation (yield) or comparison.

  • The comparison method consists of using the price per m² of assets comparable to the one being valued by multiplying it by its surface area.
  • The calculation of the exit value by capitalisation varies according to whether the asset is occupied.
    • If the asset is occupied, the current rent (or net operating income for the period) is capitalised.
    • If the asset is vacant, the annual LTV (Market Rental Value) is capitalised.