Valuation L3 Flashcards
(80 cards)
1
Q
What are the five different valuation methods?
A
Comparative (also known as the market approach)
Investment
Profits
Depreciated Replacement Cost (commonly known to the Assessors as Contractors)
Residual
2
Q
What is the Comparative Method of Valuation?
A
The main principle is the substitution principle - buyer/renter will not pay/rent more for a property than the cost of acquiring an equivalent substitute.
3
Q
When would you use the comparable method?
A
Where there are comparable transactions available.
- common in residential market
- works best in an active market with a high volume of transactions
- can also be used as a cross-check with other valuation methods
- Red Book guidance suggests best practice is where there are three or more transactions
4
Q
What should comparables be?
A
- comprehensive (what is included in sale/lease, any incentives, etc)
- verifiable (transactions should be confirmed by research/networking, e.g ROS for Assessors CT)
- similar (physical characteristics, size, location, etc)
- arm’s length (two unconnected parties with no special value e.g. family sale)
- consistent with market practice (comparable changed hands for same purpose/same way as most market transactions and not be statistical outlier or represent a special purchaser)
5
Q
What are some sources of Comparable evidence?
A
- Direct transactional data (completed, verified transactions - best quality)
- Publicly available information (land registry - time lag, lack of detail)
- Databases (external/in-house can provide good comparable data)
- AVM Output (reliability depends on quality of data input, work best where high volume of transactions)
- Asking Price (caution as it is an appraisal and forward-looking attempt to influence market)
- Historic Information (sourced from reports/research however can be out of date)
- Indicies (can identify trends, hoewver broad stats and would not stand up in court, e.g. NW House Price at VAC/Tribunal)
6
Q
What are some critiques of the Comparable Method?
A
- volume/type/density of some developments produce so many variables that comparable evidence not always available
- without high volume of transactions a single sale can distort analysis
- less useful where markets are unstable with period of rapid growth or decline
7
Q
How is the comparable method incorporated in other valuation methods?
A
Residual - central in calculating Gross development value (GDV)
- Investment - used to compare rental values and establish yields
- profits - compare turnover with like-for-like to establish HAT with REO.
- DRC - used to provide land rate
8
Q
When would you use the Investment Method?
A
- where there is an income flow and property is purchased as an investment (e.g buy-to-let residential properties, institutional investors/pension funds/insurance companies/crown funds for commercial properties)
- should be used wherever there is a rental income
8
Q
What is the Investment Method?
A
- valuation approach that provides an indication of value by converting future cash flows to a single current capital value
- key objective of an investor is to provide an income or capital growth
9
Q
What are some of the key elements of the Investment Method?
A
- Capitalisation and Yields
- Time Value of Money
- Term and Reversion Technique
- Layer Method (Hardcore)
- Discounted Cash Flow Technique (DCF)
- Rental Incentives and Rent Analysis
10
Q
What is Capitalisation?
A
Process of converting income into a capital value
11
Q
What is a yield and how would you calculate it?
A
metric that expresses potential return on the investment (specifically annual rental income, as a percentage of the property’s value)
Yield = Annual Rental Income/Capital Value (market value) x 100
12
Q
What are some different types of yields?
A
- All Risks Yield (takes into account risk, return and growth expectations - e.g. Net Initial Yield, equivalent yield, reversionary yield)
- Equated yields in DCF valuations (growth explicit)
13
Q
What is the time value of money?
A
principle that money received in the future is worth less than money received today
- factors such as risk, opportunity cost and inflation
14
Q
What is the present value of £1 and the formula?
A
used to discount future income to its present value
establishes amount needed to be invested now to accumulate future sum at given interest rate
PV = Future Value/ (1+i)^n
15
Q
What is the term and reversion technique?
A
- values the income from property in 2 stages (term and reversion)
- used to value property where a property is let at less than market rent and where rent is expected to increase at a known point in the future (e.g. rent review)
- 1st - value capital value of income flow of the term (using years purchase)
- 2nd - value market rent capatalised into perpetuity at reversion (using YP perp deferred using PV of £1)
16
Q
What is the formula for YP in perpetuity?
A
1/i(1+i)^n
17
Q
What is riskier - the term or the reversion?
A
Reversion is generally considered riskier as this is based on the current market rent which could be subject to change.
18
Q
What is Discounted Cash Flow (DCF)?
A
valuation technique that discounts future income and expenses to their present value
19
Q
When would you use DCF?
A
- Useful for when there is a lot of money coming and going at different times
- Widely used if there is a connection to financial reporting as widely understood in that sector
- commonly used to calculate worth to specific investor
- can be used to produce MV if discont rate same as market capitalisation rate
20
Q
What are the key components of a DCF calculation?
A
- periodical pattern of income (normally assumed income received annually in arrears but DCF can take into accoun the actual payment pattern
-Net Income Flow (amount of rent coming in from the asset during a period) - Discount Rate (rate used to discount future cash flows to PV. Represents target rate of return - equated yield/IRR)
-Discounted Cash Flow (income multiplied by discount rate - mney worth less in future discounted - less time passes less it is discounted)
-Internal rate of return (IRR) (discount rate at which NPV of all cash flows equal zero - represents equated yield with income growth)
21
Q
IS DCF implicit or explicit?
A
Explicit - in that yield does not incorporate growth, costs and discount rates and this is presented clearly within the cash flows.
22
Q
What is the layer method?
A
Similar to that of T&R but capitalises element of rent passing and capitalises the reversionary income discounted at a higher rate to reflect greater risk
23
Q
What is a rental incentive?
A
concession offered by landlord to attract tenants
prevalence depends on market trend (growth or decline)
24
What is headline rent?
rent stated in lease before incentives
25
what is a rent-free period and how would you deal with this?
incentive where tenant is not required to pay rent at beginning of a commercial lease
needs to be analysed to establish net effective rent (see DCF)
26
What is the net effective rent?
Rent after analysis to reflect incentives and concessions
27
What is a stepped rent?
rent increases at predetermined intervals until it reaches headline rent
28
What is the Residual Method used for?
used to value property suitable for development or redevelopment, particularly when development value is higher than value of current use.
- can help determine how much should be paid for development plot
- is it worth spending money for planning permission
-should there be a change of use
Also used in development appraisal to establish viability
29
What is the Residual calculation in its most simplistic form?
value of land = estimated value of completed development less costs associated with the development
30
What is the basic formula for a Residual valuation?
A (market value for completed development) less B (development costs including site costs) = C (developers profit)
31
Why is the Residual Method used?
the volume, type and density of each development can produce many variables, making comparable evidence less available for specific properties
32
What is Gross Development Value (GDV)?
market value of the completed development
33
What are development costs?
building costs
professional fees
finance costs
marketing
contingencies (normally round 5%)
34
Where could you source building cost information?
RICS BCIS (Building cost information service)
35
What stage of the residual valuation proposal is most complex?
specific proposals with specialist information is more complex but more accurate
early stage with vague ideas less complex but less accurate
36
What are some critiques of the Residual method?
difficult gathering accurate input information
highly sensitive to small changes
used to justify almost any figure depending on how its constructed
development process and timing of cash flows not always adequately reflected
37
What is a sensitivity analysis?
Used in residual valuations - assess how changes in key variables impact final valuation outcome
- helps understand uncertainty
-change on variable at a time to see impact on result
38
What is the cost approach?
value indication on basis buyer will not pay more for an asset than cost of acquiring equivalent substitute
39
What is the other valuation method that uses the cost approach?
DRC - Depreciated Replacement Cost
40
What is the DRC method?
valuation method based on the hypothetical cost of constructing a modern equivalent building from which depreciation is then deducted
41
When is the DRC method used?
method commonly used where properties are not intended for profit but discharge a public duty or for specialised privately owned buildings where market comparables are scarce or non-existent.
42
What are some examples of properties that use the DRC method of valuation?
Schools/universities
museums
sports stadia
fire/police stations
town halls
places of religious worship
43
What are the five stages of a DRC valuation?
- Estimated Replacement Cost (ERC)
- Adjusted Replacement Cost (ARC)
- Land Value
- Decapitalisation
- Stand Back and Look
44
What are the different kinds of obsolescence?
- physical (wear and tear)
- economic
- functional (design deficiencies relative to current requirements)
- technical (technology changes that might render redundancy)
45
How should the land value in a DRC be calculated?
costed using bona fide actual costs or in comparison with undeveloped land cost evidence in particular area for similar sized sites with similar use classes
46
What is Ebdon?
Stemming from case - Imperial College of Science and Technology V Ebdon (VO) -
consideration must be given to appropriateness of any allowance to reflect the site being "encumbered" by obsolete buildings, structures, plant and machinery, etc.
47
What else should the DRC land value consider?
possible surplus land that may be reserved for future development
may attract lower level of value but not ebdon.
48
What is decapitalisation?
rate converts the effective capital value to the net annual value
49
What are the decap rates and who prescribes these?
- 2.9% for educational establishments, healthcare facilities and places of worship
- 4.6% for the rest
Prescribed by the Scottish government under Valuation for Rating (Decapitalisation Rate) (Scotland) Regulations 2016
50
What is considered at stage 5 - stand back and look?
adjustments which affect property as a whole and have not yet been considered at the other stages e.g.
- access
- general layout
- state of industry
- relativity to local pattern of values
- negotiation between parties, etc
51
When gathering cost information for a DRC which cost should be excluded from analysis?
- non-rateable items
- VAT
- unremunerative costs e.g. duplication of tasks due to severe weather/natural disaster, "reworks", cost involved in provision of unnecessary embellishment as a personal choice
- fitting and fixtures
- grants, donations or financial assistance
52
What are some of the drawbacks of DRC?
- cost does not necessarily equal value
- land value component can distort final value if land is in a valuable location or zoned for a more valuable use that the existing property.
53
What is the Red Book commonly known as?
RICS Valuation - Global Standards
54
When was the current red book effective from?
1st January 2025
55
What is the Red Books main purpose?
to ensure consistency, transparency and confidence in valuations
56
What is the structure of the Red Book?
- Introduction
- Glossary
- Professional Standards (PS)
- Valuation Technical and Performance Standards (VPS)
- Valuation Practical Guidance Applications (VPGAs)
-International Valuation Standards
57
What are the professional standards and how many are there?
there are 2 professional standards:
PS1: compliance with standards where a written valuation is provided
PS 2: Ethics, competency, objectivity and disclosures
58
What are the valuation and technical performance standards and how many are there?
there are six VPSs:
remapped as of 2025:
- VPS 1 - terms of engagement (scope of work)
- VPS 2 - basis of value, assumptions and special assumptions
- VPS 3 - Valuation Approaches and Methods
- VPS 4 - Inspections, Investigations and Records
- VPS 5 - Valuation Models
- VPS 6 - Valuation Reports
59
How many VPGAs are there?
11 including,
valuations for financial reporting, valuations for secured lending, valuations for businesses and business interests, valuation of trade related properties, valuation of arts and antiques, etc.
60
Are all parts of the Red Book mandatory?
No -
PS and VPS is mandatory in MOST circumstances
VPGAs are not mandatory but encourage best practice
61
When are PS and VPS not mandatory?
- when valuer providing a statutory function
- providing valuation advise expressly in prep or during course of negotiations or possible litigation
- providing a valuation solely for internal purposes (not communicated to any third party)
- providing a valuation in connection with certain agency or brokerage work (disposing or acquiring an asset)
- anticipating giving evidence as an expert witness
62
What standards do RICS align with when considering the Red Book?
The International Valuation Standards (IVS) as set by the International Valuation Standards Council (IVSC) of which RICS is a part of
63
What are the International valuation Standards?
provide a higher-level but less detailed level of standard that RICS aims to meet and exceed
64
What are the key updates in the Red Book 2025?
- reflects updates to IVS, incorporates changes from the RICS valuation review and aims to future-proof valuation practice
- addresses technology like AVMs (VPS5) whereby AI might now be prevalent - only considered a written valuation if valuer applies professional judgement to the output
- integrates ESG (Environmental, social, governance) factors throughout the whole of the red book.
- Introduction of a sixth VPS (VPS 5) - ensures line up more directly with the IVS.
65
What are the IPMS?
International Property Measuring Standards -
IPMS 1 - GEA (Gross External Area)
IPMS 2 - GIA (Gross Internal Area)
IPMS 3 - NIA (Net Internal Area)
66
What is the purpose of the IPMS?
to create consistent measurements of a property globally
67
What is currently in place for property measuring guidance?
The code of measuring practice 6th ed
68
Is the code of measuring practice mandatory?
No but considered best practice globally and can be brought up in court as to why this practice hasnt been adopted
69
Are IPMS mandatory?
Yes - they will gradually replace the code of measuring practice
70
What of the IPMS are already mandatory?
IPMS Office 1,2 and 3 effective 2017
IPMS Residential 1,2 and 3 effective 2017
71
What is the definition of IPMS 1
sum of the areas of each floor level of a building measured to the outer perimeter of external construction features
72
What is the definition of IPMS 2
sum of areas of each floor measured to the internal dominant face of the perimeter walls
73
What is the definition of IPMS 3
floor area available on an exclusive basis to an occupier, excluding standard facilities and shares circulation areas
74
What are the RICS five rules of conduct?
1. members must be honest and act with integrity
2. members and firms must maintain their professional competence and ensure services are provided by competent individuals
3. members must provide a good quality and diligent service
4. members and firms must treat others with respect and encourage diversity and inclusion
5. members and firms must act in the public interest
75
What is the main principle behind undertaking a profits method valuation?
That its value is directly related to its earning potential
76
What is FMP and is this different to the Assessors?
Fair Maintaining Profit and the Assessor uses HAT (Hypothetical Achievable Turnover)
77
When would you use the profits method?
when there are a lack of comparisons or lack of income stream to capitalise
- changes hands not very regularly and bought/leased based on income generating potential
78
What are the steps in conducting a profits method valuation?
obtain estimated gross earnings
deduct expenses for net earnings
apply YP to net profit
stand back and look
79
What are some of the drawbacks to a profits method valuation?
- market knows best and these methods arent fully able to grasp market value
- assumption hypothetical tenant is trading solely from property when often profit flow part of a wider business
- obtaining necessary accounts can be challenging
- Establishing the correct Years Purchase (YP) can be difficult because transactions for these types of properties are often opaque, kept confidential, and involve sensitive business information
- Specialists tend to undertake this method due to the difficulty and risk, and the relevant databases are not publicly available
