Income Approach - Short-cut DCF

The Short-cut DCF method is based on a model developed by Professor Neil Crosby of the University of Reading (and ultimately based on earlier work by Wood and Greaves). The RICS have encouraged use of the method in appropriate circumstances. The Short-cut DCF is an adaptation to property valuation of the DCF method, which is widely used in finance.

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In the Short-cut DCF, the passing rent, which is constant (in nominal or real terms) for the duration of the rent period, is discounted at an appropriate rate of return (possibly derived by reference to the risk-free rate of return obtained on government bonds, to which is added an allowance for risk and an allowance for the illiquidity of property assets). The reversion is discounted at the market-derived All Risks Yield (ARY), which correctly implies growth in the reversionary income stream. The reversionary income is the current Estimated Rental Value (ERV) inflated by an appropriate annual growth factor (or CAGR - Compound Annual Growth Rate). The crux of the Crosby-Wood model, and that which sets it apart from the customary DCF, is that the growth factor is derived by means of formula, as a function of the rate of return and the All Risks Yield. For example, if the rate of return is 10% per annum, the ARY is 8% per annum and rent is reviewed annually, then the growth factor will be 2%. (This simple subtraction only works when rent is reviewed annually - in all other situations the growth factor is derived by use of the Crosby formula.) Thus the Short-cut DCF produces a mathematically consistent valuation.