Discounted Cash Flow (DCF)

Discounted cash flow values a property by projecting its net operating income over a holding period, adding a sale price at the end, and discounting every year back to today at a required rate of return. It is what replaces single-year NOI divided by a cap rate when rents, expenses or vacancy are expected to change.

Direct capitalization, $18,270 divided by 6.5% for $281,077, assumes this year's NOI is representative. A DCF model instead lays out ten years of NOI, say $18,270 growing 3% a year to $23,840, plus a reversion value in year ten, and discounts each figure at perhaps 9%. The answer can land above or below the cap rate value depending on the growth and discount assumptions, which is both the strength of the method and its weakness.

Wikipedia's article covers the general finance version, net present value and internal rate of return. In real estate, the inputs are still NOI. Every year of the projection is an NOI line, built from the same rent, vacancy and expense assumptions the calculator uses, just repeated with growth rates applied. A DCF built on an NOI that omits reserves and management compounds the error for ten years.

Further reading: Discounted Cash Flow (DCF) on Wikipedia.