DCF (discounted cash flow)

The DCF (discounted cash flow) method is the explicit form of the income approach. Instead of capitalising a single rent with a rate that implicitly contains every assumption, it sets out year by year what the property will produce and cost, then brings each amount back to today’s value with a discount rate. The Charte de l’expertise en évaluation immobilière (French property valuation charter) sums it up: the value of the property equals the sum of the present value of all future cash flows and of the resale value at the end of the holding period.

It suits assets whose income is going to change in a predictable way: a building with several leases expiring, partly vacant premises, a hotel, a property needing heavy works, a refurbishment project. For a home let on a stable basis, direct capitalisation is enough and the Charter recommends it.

Where the rule comes from

Title III § 2.3 of the Charter (6th edition, November 2025) describes the model in four steps. The holding period, generally five to ten years, must allow the existing leases to expire, re-lettings to take place and at least one market cycle to run. The cash flows distinguish potential gross income, effective gross income after vacancy and arrears, and net operating income after charges; they exclude corporation tax, debt service and accounting depreciation. The discount rate reflects the return expected by investors. The exit value capitalises the final year’s income at an exit yield generally equal to or higher than the current rate. § 2.2.2 warns against double counting growth in both the cash flows and the rate.

In a valuation report

I present an annual table of rents, vacancy, non-recoverable charges, works and re-letting costs, with sourced assumptions (indexation, market rent, re-letting periods). I justify the discount rate and the exit yield, calculate the value, then test its sensitivity to the main variables. The report cross-checks the result against direct capitalisation and comparison where evidence exists, and states whether the assumptions are those of the market (market value) or those of a given investor (investment value).

Example

A small office building let at €120,000 per year, including one lease of €60,000 expiring in two years with a market rent of €52,000. The seven-year model assumes: rents indexed at 2 % per year, six months’ vacancy and €15,000 of re-letting works in year three, non-recoverable charges of 10 %. Net income discounted at 7 %: €620,000. Resale value in year 7, net income capitalised at 7.25 %: €1,610,000, or €1,002,000 discounted. DCF value: €1,622,000, rounded to €1,620,000. Direct capitalisation of the current net income at 6.75 % gives €1,600,000: the two approaches converge.

Not to be confused with

Direct capitalisation is an implicit DCF with constant income. The residual method is also a cost-deduction method, but directed at a building project and a single exit value.