Encyclopedia
Discounted cash flow (DCF)
A valuation method that projects future cash flows and discounts them back to today's value.
For example: A buyer of a multi-tenant building models lease expiries and vacancy in a DCF instead of relying on one year's net operating income (NOI, the income left after running costs). (Illustration only, not a real deal.)
This is a general industry term with no single official definition. Your lease or contract wording controls.
Example only, not a real client. Say you are valuing a building with leases rolling over at different times. A discounted cash flow model lays out income and costs year by year, including vacancy at each rollover and a sale at the end, and then discounts them back to today to estimate value.
What I’d tell a friend
A DCF model helps you see risk year by year. Question each assumption, especially the ones far in the future.
Why it matters to you
It's only as good as its assumptions. Small changes in rent growth, vacancy or exit price can move the value a lot, so test the inputs.
How to use it in your deal
Buyers should build the DCF from lease-by-lease data: current rents, escalations, expiries, renewal odds, downtime, leasing costs, tenant inducements, capital spending and operating costs. Test what happens if rents are lower, vacancy longer or the exit capitalisation rate (cap rate) higher; small changes can swing value a lot.
Compare the result with direct capitalization and comparable sales. Sellers presenting a DCF should explain assumptions; buyers will rerun it. Appraisers often use it alongside other approaches. Lenders care more about current income and debt coverage than long forecasts. Owners can use DCF to decide whether to hold, sell or renovate. Keep it simple enough to understand; a model nobody can explain isn't helpful.
Mistakes I see
Optimistic rent growth. Low exit cap rates. Ignoring leasing costs and downtime. Treating the output as precise.
In BC and Vancouver
No statute; appraisal standards guide professional use. Interest rate data from the Bank of Canada helps set discount rates.
Official sources: Bank of Canada: key interest rates · BC Assessment appeal guide
What it is
A discounted cash flow model estimates value by projecting future cash flows, then converting them to today’s dollars using a discount rate that reflects risk.
It suits properties with uneven income, such as multi-tenant buildings or ones with leases ending soon.
Key inputs
Look at rent growth, vacancy and downtime at lease expiry, leasing costs, capital spending, the exit cap rate and the discount rate.
Small changes to these can move the value a lot, so compare the model with comparable sales and a simple cap rate check.
Questions to ask before you sign
- What are the key assumptions?
- What happens if rents are lower?
- What exit cap rate is used?
- How does it compare with other methods?
- What discount rate makes sense?
Exit cap and CapEx make or break a DCF
A discounted cash flow is only as honest as its exit capitalisation rate and capital expenditure line. Using a tighter exit cap than today’s entry rate on a long hold needs a good reason; many models do the opposite to stay conservative.
Pick discounted cash flow when lease rollovers and CapEx matter. Pick a simple cap rate when income is stable and durable. Then gather diligence that matches the method.
I can help pressure-test assumptions; an appraiser owns a formal report.
Keep reading
Related terms: Internal rate of return (IRR), Net operating income (NOI)
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General information for British Columbia only. It isn’t legal, tax, accounting or financial advice, laws and rates change, and reading it doesn’t make you my client. Any numbers or scenarios are hypothetical. Check the linked official source and talk to a lawyer, accountant or other qualified professional before you act or sign anything. See the terms and disclaimer.