In a bid to strengthen oversight of, and increase confidence in, commercial property valuations, RICS has been looking to implement various changes to the profession, following the recommendations set out by Peter Pereira-Gray in his Independent Review of Real Estate Investment Valuations, published in January 2022. One topic of particular interest is the contentious issue of using the discounted cashflow (DCF) method when valuing commercial properties for investment and reporting purposes.

Ian Mackie

Ian Mackie

Following concerns that valuers are not always transparent in their investment performance reporting, or reacting with adequate speed to market changes, the use of DCF could make the profession more agile.

For years, the UK property market has primarily used the traditional growth-implicit approach of valuation, also known as the ‘all-risk yield’ method. This involves adopting a number of implicit valuation assumptions, meaning the resulting valuations are not always transparent. The proposed changes would represent a shift to using more explicit valuation methods, and would involve the estimation of the value of an investment by forecasting a specific period of its expected future cashflows.

In his report, Pereira-Gray called for the use of DCF as the principal model applied in preparing property investment valuations, calling it “increasingly important and suitable for modern markets”.

Citing factors such as economic uncertainty brought about by Covid-19 and present geopolitical developments, RICS conducted a public consultation into the use of DCF, which closed in April. The wider use of DCF represents a significant change for the real estate industry and the valuation profession. This method will allow valuations to keep pace with rapidly changing market conditions.

Recent volatility has created price fluctuations in property markets. Following the outbreak of Covid, many expected a shock to markets. Instead, the following year saw assets reach peak prices. Then, in May 2023, Bank of America’s global monthly fund manager survey showed that 19% of managers cut their commercial real estate allocations to their lowest levels since 2008.

With such fluctuations, it is becoming increasingly clear that valuers must be explicit concerning their assumptions when performing valuations to inspire clarity and confidence, not just in those relying upon them, but in the industry as a whole. As Pereira-Gray put in his report: “With an understanding of the possibilities, greater certainty might be placed on the valuation.”

Change is not easy, but the commercial real estate valuation profession must keep up with market demands if it is to retain credibility with clients, investors and market analysts. In today’s environment, properties must be viewed in a different way, and factors such as the carbon footprint and energy efficiency of buildings, and the requirements to upgrade older buildings to modern standards, must be considered. Valuers need tools to help them ensure their valuations take these considerations into account.

While it may take some time for stakeholders to adapt to this transition, it marks an important step for the industry as it strives to adapt to today’s evolving market conditions. Healthy industry debate is a crucial component to this modernisation, and the outcome and insights from the consultation will be eagerly awaited by the industry.

Ian Mackie is managing director of Berkeley Research Group’s real estate and fixed asset valuation practice