VALUATION

Question 1

What are the five methods of valuation?

Answer 1

Comparable method
Investment method
Profit method
Residual method
Depreciated replacement cost method/contractor’s

Question 2

What is the residual method and how is this applied?

Answer 2

• The main aim of the residual method of valuation is to establish how much a purchaser should pay for
  a development site.
• The gross development value is established first of all and there after all the costs associated with
  undertaking the development are then deducted.
• This leaves a surplus amount remaining which is also known as the residual value.
• This represents how much the developer can afford to pay for the development site or property.
• The GDV or gross development value forms a key part of the calculation and this is the aggregate
  market value of the development based on the special assumption that the development is complete at
  the date of valuation.
• The costs considered and deducted from the GDV will include – site preparation, construction, sales
  and marketing, contingency, financing fees and developer’s profit.

Question 3

When is the Profit Method used and how is this undertaken?

Answer 3

• The profits method is derived from trade related properties where the value is derived from the
  business and its trading potential.
• This trading potential is the profit that a reasonably efficient operator would expect to realise from
  occupying the property.
• Examples of when the profits method would be used would include for hotels, schools, cinemas and
  theatres.
• The common characteristics of these properties is where the property has been designed for a specific
  use and the value is linked to what the owner can generate from the property.
• The value therefore reflects the trading potential of the property and it includes the property interest,
  business and locational good will and fixtures and fittings all reflected as a single figure.
• The Income and expenditure forecast is based on historical and comparable information.
• This forecast represents the fair maintainable turnover and fair maintainable operating profit that a
  reasonably efficient operator would hope to achieve.
• This is therefore considered a reasonably accurate forecast of the properties trading potential.
• The actual performance is compared with similar trade properties to determine whether the fair
  maintainable turnover is realistic based on current market conditions.
• As a final step the fair maintainable operating profit is capitalised at the appropriate rate of return to
  reflect the risks and rewards of the property to determine its trading potential. Evidence of accurate
  comparable market data should be analysed and applied.

Question 4

What is the depreciated replacement cost method of valuation and
how does this work?

Answer 4

• The depreciated replacement cost method provides an indication of value based on the buyer paying
  no more or no less than the cost to obtain the asset based on the current equivalent.
• The involves calculating the replacement cost of the asset with its modern equivalent including
  deductions for physical deterioration and all other relevant forms of obsolescence.
• This method is known as the method of last resort and used when it is impractical to use all other
  valuation methods.
• The cost approach is used to value unusual properties where there is no active market such as mosques,
  wharfs or refineries.
• Under the cost approach the capital value is determined by calculating the cost of building the
  equivalent asset and the purchase land value.
• The replacement build cost should be calculating using new and cost effective building materials and
  techniques.
• The total value of the new property is then adjusted for deterioration using evidential information and
  recent transaction values to calculate the land purchase cost.

Question 5

What is the comparable method of valuation and how does this work?

Answer 5

• The comparable method primarily uses sales data of properties that have recently been sold focusing
  on assets that have a similar size, location, condition, features and specifications.
• The comparable method is underpinned by comparable evidence which is identified, analysed and
  applied to the real estate that is to be valued and is therefore fundamental to producing a sound
  valuation that can stand scrutiny from the client and market.
• The valuer will compile a schedule of evidence that will contain details about the property such as
  building age, quality, location, tenure, size, transaction price, date of sale, price per sq.ft - all of which
  can be used for the purposes of comparison with other similar properties.
• The comparables gathered should be comprehensive that is to say there should be several comparables
  rather than this being singular, they should be recent and therefore representative of the current market
  conditions, very similar and consistent with local market practice.

Question 6

What are the different Purposes of valuation?

Answer 6

• Valuation for Financial Reporting.
• Valuation for Commercial Secured Lending Purposes.
• Valuation for Residential Mortgage Purposes.
• Valuation for Capital Gains Tax, Inheritance Tax, Stamp Duty Land Tax.
• Valuation for Compulsory Purchase and Statutory Compensation.

Question 7

What is the Red Book?

Answer 7

• The RICS Red Book contains mandatory rules and best practice guidance for members who undertake
  asset valuations.
• The Red Book includes:
  o International Valuation Standards
  o Red Book UK – Issued since 2015.
• Key Sections of the Red Book include:
  o Introduction.
  o Mandatory Valuation Standards.
  o Advisory Valuations Standards.
  o Valuation for Financial Reporting.
  o Valuation of Charity Assets.
  o Valuation for commercial secured lending purposes.
  o Valuation for compulsory purchase and statutory compensation.

Question 8

What steps would you take following your valuation instruction?

Answer 8

• Obtain details of the property.
• Undertake a conflict of interest check.
• Obtain a signed letter of instruction.
• Confirm the purpose of the valuation.
• Undertake information gathering including confirmation of the purchase price.
• Identify ratings, planning & environmental information.
• Carry out the inspection & measurement of the property.
• Research market values.
• Compile the valuation report.
• Check valuation internally including sign off with any relevant signatories.
• Report to the client and address any queries.
• Submit an invoice.

Question 9

What details would you expect to see covered in a Banks Letter Of
Instruction on a valuation for secured lending?

Answer 9

• Borrower.
• Property.
• Purpose.
• Conflicts.
• Details of loan.
• Who the report is to be addressed to.
• Special Assumptions.
• Details on where to get information and how to get access to the property.
• What the report should contain for example areas, condition, tenancies & lease, environmental
  conditions, the market, relevant risks, valuation amount and any fees that are applicable.

Question 10

What are the different methods of valuation?

Answer 10

• Comparable.
• Income method.
• Profits.
• Residual.
• DRC (Depreciated Replacement Cost).

Question 11

What is meant by the term Market Value?

Answer 11

• The estimated amount for which an asset should exchange on the date of valuation between a willing
  buyer and a willing seller in an arm’s length transaction after proper marketing wherein the parties had
  each acted knowledgeably, prudently and without compulsion.

Question 12

What is the definition of market rent?

Answer 12

• The estimated amount for which a property, or space within a property should lease (let) on the date of
  valuation between a willing lessor and a willing lessee on appropriate lease terms in an arm’s length
  transaction and after proper marketing wherein the parties had acted knowledgably, prudently and
  without compulsion.

Question 13

What is Hope Value?

Answer 13

• Hope value is the term used to describe the market value of land based on the expectation of getting
  planning permission for development on it. This differs from the existing use value which is what the
  land or property is worth in its current form.

Question 14

What is Marriage Value?

Answer 14

• The extra value that arises from the merger of two physical or legal interests.

Question 15

Definition Of Special Value?

Answer 15

• An extraordinary element of value over and above market value.

Question 16

What does TEGOVA stand for?

Answer 16

• The European Group Of Valuer’s Association unites 70,000 national valuer’s associations from 38
  countries.
• The organisation seeks to make valuation compatible across the EU.
• TEGOVA aims include:
  o A common European Valuation Report for Residential Property.
  o New Guidance Notes and Information Papers on subjects of real interest to practicing valuers.
  o A comprehensive approach to Valuation Methodology including detailed exposition of key
  concepts such as income approach and depreciated replacement cost.

Question 17

What is the IVSC?

Answer 17

• The International Valuation Standards Committee.
• It’s principle interest is to publish valuation standards and procedural guides for valuation of assets for
  financial statements.
• The IVSC recognises two specific International Valuation Standards:
  o IVS1 – Market Value basis of Valuation.
  o IVS2 – Valuation bases other than Market Value.
• The IVSC also recognises two applications:
  o IVA1 – Valuations for Financial Reporting.
  o IVA2 – Valuation for Lending Purposes.

Question 18

What is the difference between specialist properties and specialised
properties?

Answer 18

• Specialist – Trading properties such as hotels, cinemas, pubs where the property is designed to perform
  a specific purpose.
• Specialised – These include chemical plants, places of worship. These types of properties are very
  rarely sold on the market except being exchanged within the industry or business they are a part of.

Question 19

What is the difference between Market Rent and Estimated Rental
Value?

Answer 19

• Market Rent assumes Vacant Possession and is the amount of rent anticipated for the use of the
  property, in comparison with similar properties in the same area.
• Estimated Rental Value takes into account further considerations about the property assuming the
  building is occupied. For example there will be due consideration of the specific lease terms.

Question 20

When would you use Term & Reversion vs. Hardcore?

Answer 20

• These valuation approaches are utilised when the terms of the lease and incoming rental income are expected to change in the near future.

Question 21

What is the Term & Reversion approach?

Answer 21

• The term and reversion method is used when the property has an existing lease in place that is due to
  expire.
• The existing lease terms are considered separate from the expected new lease terms within the valuation
  approach.
• In this instance the property is said to have reversionary potential taking into account the new lease
  terms.
• In other words the existing term is valued separately from the reversion (new lease terms)

Question 22

What is the Hardcore / Layer approach?

Answer 22

• The layer or hardcore valuation method is used as an alternative to the term and reversion approach.
• It considers the current market rent being received and applies this on a perpetual basis.
• The difference between the current rent being received and expected market rent at the time of the
  lease renewal is also considered on a perpetual basis.
• The two separate values are then added within the calculation.

Question 23

What is the definition of Equivalent yield?

Answer 23

• The equivalent yield is a weighted average of the net yield from current rental income and all future
  reversionary income.
• For example if a 5% yield is applied on the hardcore rental income currently being received and a 6%
  yield is applied on future reversion income the uniform equivalent yield would be weighted to consider
  both of the individual percentages being applied at 5.5%.
• This approach is often simpler for valuers as they can apply a yield to the entire income stream rather
  than having to value hardcore and reversionary income separately.

Question 24

What is the definition of Equated Yield?

Answer 24

• The equated yield is the yield on a property investment which takes into account growth in future
  income.
• This is not applicable to reversionary situations, where the increase in income on reversion is to the
  market value as estimated at the present time

Question 25

What is Goodwill?

Answer 25

* Goodwill is an intangible asset when property or real estate is being sold or purchased. * Goodwill is a value within the transaction that is higher than the sum of the net fair value. * For example the Goodwill portion of the transaction maybe included due to special features of the asset being exchanged which may be associated with brand name, local customer base and excellent reputation. * The Goodwill element will create a special value over and above the value of the land or building being exchanged.

Question 26

What are the different types of Goodwill?

Answer 26

* Purchased Goodwill: o Purchased goodwill is created when an asset is exchanged for an amount above the fair market value. o It is accounted for on a company’s balance sheet and is shown as an asset. o This is the only kind of goodwill that can be recognised on a companies accounts. * Inherent Goodwill: o Inherent Goodwill is created over time as a non measurable asset held by a property or company. o This can be derived from factors such as favourable location, excellent reputation, solid local customer base, good brand image and brand name. o Inherent Goodwill is not recorded on a companies balance sheet as an asset and is only realised financially at the time the property or company in consideration is sold or exchanged.

Question 27

What is the difference between a residual valuation and a development appraisal?

Answer 27

* A Development Appraisal does not form part of a Red Book valuation standard whereas a Residual valuation is. * Development Appraisals are based on worth where one or more valuations are coupled with professional advice, analysis and opinion. * Development Appraisals takes into account time (phasing) whereas Residual valuation methods do not. * Development Appraisals use client & agent input whereas Residual valuations must use market lead inputs. * Development Appraisals are used to determine whether profit levels are obtained at an acceptable level whereas Residual methods are used to determine market value.

Question 28

When would you use the Discounted Cashflow Valuation Method?

Answer 28

* Where there are no comparable market transactions, the explicit DCF model provides a rational framework for the estimation of Market Value. * It can also be applied if there is expected short term market volatility present within the transaction for example if a tenant within a rental property is due to terminate their lease. * It can also be used if multiple investments are being compared side by side to support with long term investment decisions. * The estimated cash flows are projected over an assumed investment period in addition to an exit value at the end of the investment period. * The cash flow is then discounted back to the present day value at a discounted rate (also known as the desired rate of return) that reflects the perceived level of risk. * A discount rate is applied to reflect market and property-specific risks. * To arrive at the estimated revenue cash flow specific leasing patterns including rent reviews, lease renewals or re-lettings on lease expiry, void costs need to be considered. * The exit valuation needs to reflect the rental growth and unexpired terms of the leases at the exit date. * The assumptions and forecasts forming part of the calculation need to be set out clearly

Question 29

How would you value a property where there are no comparables?

Answer 29

* The discounted cashflow method can be used where no comparable market transactions exist. * The estimated cash flows are projected over an assumed investment period in addition to an exit value at the end of investment period. * The cash flow is then discounted back to the present day value at a discounted rate (also known as desired rate of return) that reflects the perceived level of risk. * The assumptions and forecasts forming part of the calculation need to be set out clearly.

Question 30

What factors effect yields?

Answer 30

* Covenant. * Location. * Specification. * Rent levels. * Growth potential. * Asset management & development value.

Question 31

What is Face Rent & Effective Rent?

Answer 31

* Face rent is a rent figure that excludes any incentives such as rent-free periods or rent reductions or fitout contributions. * Effective rent takes into consideration any incentives provided to the tenant such as to you as the tenant.

Question 32

Define all risks yield

Answer 32

* All risks yield (ARY) presents the rental revenue of a property as an annual percentage of the property cost * All risks yield is calculated by dividing the annual rental income by the properties value and multiplying this by 100 to give the percentage all risk yield.

Question 33

What are deleterious materials and how do they effect value?

Answer 33

* Deleterious materials are considered as prohibited and have an effect on the structural integrity performance and longevity of a property. * They can result in non-compliance with building regulations and decrease a properties value.

Question 34

What are the main components of a valuation report?

Answer 34

* Tenure. * Date of valuation. * Extent of inspection and who inspected. * Opinion of value in words and figures. * Allowance for VAT. * Third party references. * Clause prohibiting publication. * External or independent valuer. * Date of report. * Statement that the valuer is qualified.

Question 35

How would structural defects be reflected in your valuation report?

Answer 35

* Draw clients attention to them. * Advise them to have structural survey done. * Can't comment on area outside of ones expertise * Seek and obtain cost input to remediate and include within report.

Question 36

Are you allowed to know the purchase price when valuing?

Answer 36

* The valuer must request this and also verify it. * If your valuation differs you must state why. * This must be based on market evidence and bona fide.

Question 37

You are found to be negligent in your valuation, what can your client do?

Answer 37

* The complainant can demonstrate the losses and pursue the valuer or valuing company through the courts for the losses incurred. * Merrett vs. Babb case proved that valuers and not firms can be pursued. * This highlights the importance of having PII and run off cover in place.

Question 38

What would you caveat in a valuation report?

Answer 38

* Publication. * Confidentiality. * Deleterious Materials. * Planning. * Taxation. * Information supplied. * Environmental matters.

Question 39

How would you rentalise the reception of an office building?

Answer 39

* 50% if single tenant. * Not at all if multi-let.

Question 40

What items are contained within your terms of engagement but not referenced within your Valuation report?

Answer 40

* Reference of the professional Fees for undertaking the valuation.

Question 41

What is in your Valuation Report and not in your Terms Of Engagement?

Answer 41

* Opinion of value. * Valuation approach.

Question 42

Please provide some examples of Conflicts Of Interest?

Answer 42

* Acting for buyer and seller of a property in the same transaction. * Acting for two or more parties competing for an opportunity. * Valuing for the lender where advice is also being provided to the borrower. * Valuing a property previously valued for another client. * Undertaking a valuation for third party consumption where the valuers firm has other fee earning relationships with the client. * Valuing both parties interests in a leasehold transaction.

Question 43

What is meant by the term passing rent?

Answer 43

* The annual rental income currently generated by a property as recorded on the balance sheet date. * The passing rent generated by the property on the balance sheet date may be more or less than the estimated rental value. * Passing rent excludes any rental income when a rent free period is in effect and is based on actual income received.

Question 44

Why did the report include an ‘opinion’ and not an actual valuation?

Answer 44

* Case law built up historically has found that providing valuations are in accordance with the RICS Red Book a value based on opinion cannot be wrong. * Providing that the valuation is found to be within reasonable tolerances the surveyor cannot be considered wrong in their opinion. * If the valuation was provided based on an actual value this would not necessarily be accurate and may leave surveyors open to be pursued through court action.

Question 45

Please explain your understanding of the rotation rules for valuation contained within the RICS Red Book UK Supplement?

Answer 45

* The RICS released an updated UK supplement of the Red Book in January 2022 to update its recommendations around mandatory rotation cycles for regulated valuations. * The new rules mean that firms undertaking valuations for regulation purposes will not be able to repeat this service for more than ten consecutive years. * This will require a change or rotation to an alternative valuation firm with the aim of improving transparency and serving the public interest. * The new regulations will take effect on 1st May 2024 with the RICS providing a series of briefings to help the industry understand this new requirement.

Question 46

What is the hierarchy of evidence?

Answer 46

Category A - direct comparables * contemporary, completed transactions of near-identical properties for which full and accurate information is available; this may include data from the subject property itself * contemporary, completed transactions of other, similar real estate assets for which full and accurate information is available * contemporary, completed transactions of similar real estate for which full data may not be available, but for which enough reliable data can be obtained to use as evidence * similar real estate being marketed where offers may have been made but a binding contract has not been completed and * asking prices (see 4.1.4 above). Category B - general market data * information from published sources or commercial databases; its relative importance will depend on relevance, authority and verifiability * other indirect evidence (e.g. indices) * historic evidence and * demand/supply data for rent, owner-occupation or investment.) Category C - other sources * transactional evidence from other real estate types and locations, and * other background data (e.g. interest rates, stock market movements and returns which can give an indication for real estate yields)