Multifamily valuation in a volatile market: DCF vs. direct capitalization

Redefining multifamily valuation in the short and long-term

Multifamily owners and investors are navigating a more volatile and complex environment where revenue and expenses are less predictable and uncertainty is everywhere.

Rent growth has pulled back from white hot levels, and in some metros, fundamentals are softening as the market works to absorb new supply. At the same time, many operators are facing higher operating expenses due to rising inflation, insurance premiums, and labor costs.

Yet the turbulence in today’s market has underscored the importance of discounted cash flow modeling (DCF). DCF modeling is essential for accurate, transparent, and strategic multifamily valuation – for both short-term “gut checks” and long-term assessments.

Companies are also recognizing the advantages of replacing legacy proprietary systems, often built on standalone spreadsheets, with purpose-built solutions that provide greater scalability, consistency, and advanced data & analytics capabilities that better position them for the future.

Replacing legacy models

Direct capitalization valuation (direct cap) has been the traditional “go-to” method for determining property valuation snapshots by appraisers. Property values are estimated by dividing a single year's net operating income (NOI) by a capitalization rate (cap rate). This simplified approach is useful for properties with stable income, providing a quick estimate of value by using the formula:

Value = Stabilized NOI / Cap Rate

However, while direct cap is a fast and easy way to assess values in a steady environment, such as a typical period of 3% rent growth, it is less effective in today’s market where extremely similar properties can have very different cap rates due to short-term flux. “Direct cap really doesn’t capture everything you need to consider in today’s market,” says Troy Sivak, Senior Director, Valuation Advisory at Altus Group.

The preferred method today is DCF modeling because it tracks differing cash inflows and outflows to determine a property's financial viability and future performance. It provides a clear, detailed picture by itemizing each income item (such as rent) and outlay (operating expenses, capex, etc.). “DCF modeling for multifamily has become essential, not just for institutional investors but for any firm looking for a credible, defendable view of a property’s value,” says Sivak.

DCF versus direct cap valuation

Direct cap provides a single-year snapshot of valuation, which works during periods where market conditions – and inputs – are stable. However, the method falls short in times where the market is seeing a lot of change. Direct cap models don’t take into account year-to-year fluctuations in items such as rent concessions, operating expenses, or even taxes.

For example, Maryland is one state that reassesses real estate property values every three years. What that means is that any property tax increases would need to be phased in every three years, which would not be captured in a direct cap that focuses on a single year, but could be accounted for in DCF modeling.

Especially during periods where interest rates aren’t stable, insurance costs are soaring, and supply and demand is a bit of a roller coaster ride, multi-year forecasting becomes really important, notes Sivak. “You can take many different variables up or down to come up with a valuation that is more scientific than what you can capture in a single-year snapshot,” he says.

DCF modeling delivers the ability to consider realistic assumptions that include:

• Vacancy and lease-up timelines

• Rent growth and concessions

• Operating expense variability

• Capex and other irregular outays

DCF modeling has the flexibility to consider different scenarios and assumptions related to project performance over time, which should be important to any investor or manager who needs to understand asset-level risk and portfolio-level cash flow impacts. Additionally, DCF allows you to get more granular on the expense side. For example, one can assume that insurance premiums will increase 10% per year in years one and two and then stabilize in year three. “Asset managers are compensated for the value they create, and DCF modeling helps them truly understand how that value evolves,” says Sivak.

Institutional investors and large funds already rely on DCF as a standard. Fannie Mae and Freddie Mac also use DCF templates in their application processes. Combined, the two agencies originated $110 billion in multifamily loans last year, which speaks to the market penetration for investors and developers already using DCF modeling.

Leveraging purpose-built DCF models

The multifamily industry is continuing to evolve in its use of DCF modeling. Companies are increasingly moving away from models built on standalone spreadsheets to purpose-built centralized valuation tools, such as ARGUS Intelligence and Forbury. “With a DCF model on our centralized valuation tools, you can roll up 20 properties, adjust vacancy by 200 basis points, and see the impact instantly. Doing that as a standalone spreadsheet model means touching 20 different files,” says Sivak.

Some of the downsides to standalone spreadsheets include:

• Models that become overly complex and error-prone

• Hard-coded assumptions that are difficult to audit or adjust

• Limits the ability to standardize your model across assets and/or roll up data for portfolio insights

• Slows down transactions as counterparties try to unravel manually built models to understand how a valuation was calculated

In contrast, the advantages of purpose-built centralized valuation tools include:

• Consistency and repeatability across valuations

• Instant scenario testing (vacancy, rent growth, expenses)

• Easier portfolio roll-ups and sensitivity analysis

• Easier access to data platforms for benchmarking and performance tracking

“If you’re a small shop with a couple of closed-end funds, you can run your DCF in a spreadsheet. But as you get larger that platform needs to evolve. You need to use these tools to answer questions and do things that enable you to think more strategically, easier, and faster,” says Sivak. “If your CEO poses the question – ‘what happens if our vacancy goes up 2% next year?’ You have that answer immediately.”

Next-gen valuation tools

Although current volatility will eventually settle out, the need for more sophisticated modeling is here to stay. DCF is proving itself as a valuable tool that is able to provide more granular, multi-year valuation analysis and forecasting. As the industry continues to evolve, the next generation of valuation could integrate AI agents with real-time data, creating additional benefits such as:

• Automatically validating rent and expense assumptions using live market data

• Flagging anomalies when comparing to industry benchmarks

• Reducing manual research and increasing confidence in assumptions

In the future, multifamily operators and investors will be able to use agentic AI to gather real-time information rather than putting someone on the task of going out and researching and gathering information to type into a spreadsheet. “The evolution ahead is being able to see more data from external sources, and use that to inform assumptions in your model,” says Sivak.

DCF modeling provides the flexibility and transparency that both investors and regulators increasingly demand. Firms that modernize their valuation processes to centralized valuation modeling will be better positioned for what the future will demand. Choosing a centralized DCF tool means more than just better valuation accuracy during volatile times, it’s a pathway to establishing best practices around data strategy, data governance, and transparency.

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