Valuation (Level 1)

Question 1

What is the key RICS guidance relating to valuation and what does it set out?

Answer 1

RICS Valuation – Global Standards 2022 (effective 31st January 2022)

• Also known as the ‘Red Book Global Standards’
• Sets out the professional and technical standards for valuation to ensure consistency, objectivity and transparency for valuation across the world

Question 2

What are the sections set out in the Red Book Global Standards?

Answer 2

The red book is split into the following sections;

1. Professional Standards (PS) (mandatory) – defines the parameters for compliance with the Red Book Global Standards
2. Valuation Technical and Performance Standards (VPS) (mandatory) – contain specific mandatory requirements and related implementation guidance
3. Global Valuation Practice Guidance Applications (VPGAs) (advisory) – provides implementation guidance for valuations used for specific purposes, whilst not mandatory they represent best practice
4. International Valuation Standards (IVS) (mandatory) – produced by the International Valuation Standards Council the RICS has adopted and applied the IVS through the Red Book Global Standards

Question 3

What is the RICS guidance on the valuation of development property and what does it set out?

Answer 3

RICS Guidance Note on the Valuation of Development Property (2019)

• Aims to guide the valuer in the approach to development property valuations
• This guidance should be read in conjunction with the Red Book Global Standards
• Sets out the professional and technical standards for valuation to ensure consistency, objectivity and transparency for valuation across the world

Sets out the following valuation methods
o Residual Valuation Method
o Discounted Cash Flow Application
o Basic Residual Method

• Core message is that one method of valuation is seldom appropriate

Question 4

What is the core message set out in RICS Guidance Note on the Valuation of Development Property (2019)?

Answer 4

• Core message is that one method of valuation is seldom appropriate for the valuation of development property

Question 5

What is the RICS guidance for the UK?

Answer 5

RICS Valuation Global Standards – UK National Supplement (2019)

• The national supplements to the Red Book global standards are to assist members in the application of those standards in a local context
• Should be read in conjunction with the Red Book Global Standards

Question 6

What is the RICS guidance on comparable evidence?

Answer 6

RICS Guidance Note: Comparable Evidence in Real Estate Valuation (2019)

Sets out the use of comparable evidence in the valuation process:
o Outline the principles of the use of comparable evidence
o Encourage consistency in the use of comparable evidence globally
o Address issues of availability and use of comparable evidence in challenging market
conditions
o Consider the potential sources of comparable evidence and their relative
importance

Question 7

What are the 5 methods of valuation?

Answer 7

1. Investment Method
2. Profits Method
3. Residual Method
4. Comparable Method
5. Depreciation Replacement Cost

Question 8

What are the 3 different approaches to valuation?

Answer 8

1. Income Approach – investment, profits, residual
2. Market Approach - comparable
3. Costs Approach - DRC

Question 9

Can you tell me when you would use each valuation method and how you would carry it out?

Investment Method

Answer 9

Investment Method

Used to value a property with an existing income stream
1. Assess the market rent by reviewing comparable evidence
2. Capitalise the market rent using a capitalisation rate based on NIYs
3. This will provide your market value

Question 10

Can you tell me when you would use each valuation method and how you would carry it out?

Profits Method

Answer 10

Profits Method

Used to assess the value of a business or specialist properties e.g public house, petrol station, golf course

It is the Fair Maintainable Operating Profit (FMOP) capitalised at an All Risks Yield
1. Calculate the Annual Turnover
2. Subtract costs to establish Net Profit
3. Subtract an allowance for ‘wear and tear’, which gives you the FMOP
4. Capitalise using an All Risks Yield to determine the Market Value

Question 11

Can you tell me when you would use each valuation method and how you would carry it out?

Residual Method

Answer 11

Used to assess the residual land value of a development opportunity

1. Estimate the Gross Development Value
2. Subtract construction costs – design and build costs, remediation works,
   contingency fee, professional fees
3. Subtract development costs – developer’s profit, finance costs, planning costs
4. This provides your residual land value

Question 12

Can you tell me when you would use each valuation method and how you would carry it out?

Comparable Method

Answer 12

Comparable Method

Used as the basis for all valuation methods. Used to assess market rent and market value
Using comparable evidence to establish an indication of value

Question 13

Can you tell me when you would use each valuation method and how you would carry it out?

Depreciation Replacement Cost

Answer 13

Depreciation Replacement Cost

Used to value specialised properties for internal and rating purposes when there is limited evidence

The method of last resort and should not be used where there are market sales of comparable properties

Depreciation Replacement Cost = The cost of replacing an asset at the valuation date with its modern equivalent asset minus obsolescence
1. Establish an Existing Use Value for the Land
2. Add the cost of replacing building
3. Add any additional fees e.g professional fees
4. Apply an obsolescence discount

Question 14

How do you decide which valuation method to apply?

Answer 14

You review the nature of the property and the basis of valuation to establish your valuation method.

Question 15

When and why would you use one of these methods?

Answer 15

Investment Method – Used to value a property with an existing income stream

Profits Method – Used to value specialist properties and businesses e.g public house, golf course, petrol station

Residual Method – Used to value the development land and establish the residual land value

Comparable Method – Used as the basis for all valuations it is typically used to assess Market Rent or Market Value

Depreciation Replacement Cost – the method of last resort used to value specialised properties for internal and rating purposes when there is limited/no comparable evidence

Question 16

What is the purpose of the Red Book?

Answer 16

• Sets out the professional and technical standards for valuation to ensure consistency, objectivity and transparency for valuation across the world

Question 17

What factors may impact value?

Answer 17

1. Prospects for rental & capital growth
2. Quality of location – impacts market rent
3. Covenant Strength – impacts a property’s security of income
4. Use of the property – some uses are higher value than others
5. Lease terms – impacts rental growth (rent review), obligations for property owner, onerous
6. Obsolescence – is the property fit for purpose
7. Voids – gaps in income
8. Security and regularity of income – impacted by covenant strength
9. Liquidity - ease of sale

Question 18

What is your duty of care as a surveyor when undertaking a valuation and who is it owed to?

Answer 18

As a surveyor you have a duty to take all reasonable skill and care when undertaking the valuation of a property.

This duty of care will be owed to the client, either as an express or implied term of the contract under which the work is to be done

Question 19

Why is independence and objectivity important when valuing?

Answer 19

Independence and objectivity is essential to ensure that there are no conflicts of interest when undertaking a valuation.

Members must follow the mandatory requirements set out in RICS Professional Statement on Conflicts of Interest (2018)

Question 20

Is there a separate UK Red Book?

Answer 20

There is not a separate UK Red Book, however there is the RICS Valuation Global Standards – UK National Supplement (2019)

The national supplements to the Red Book global standards are to assist members in the application of those standards in a local context.

RICS are working on an update to the UK national supplement and aim to publish this in 2023.

Question 21

When was the Red Book last updated?

Answer 21

The Red Book was last updated November 2021 with the changes effective from 31st January 2022

Question 22

Does the Red Book differ from when IVS were last updated?

Answer 22

The changes to the International Valuation Standards (IVS) were also effective from 31st January 2022

Question 23

What changes were made to the updates in the Red Book?

Answer 23

• Emphasis on clearer terms of engagement
• Outlines a requirement to provide greater commentary on sustainability and wider ESG matters (covered in VGPA 8)

Question 24

Which do you follow - the latest IVS or the Red Book Global?

Answer 24

You follow the RICS Valuation – Global Standards 2022 as this has incorporated the latest IVS changes

If you follow the Red Book you will be following the IVS

Question 25

Which sections of the Red Book are mandatory and which are advisory?

Answer 25

Professional Standards (PS) = MANDATORY Valuation Technical and Performance Standards (VPS) = MANDATORY Global Valuation Practice Guidance Applications (VPGAs) = ADVISORY International Valuation Standards (IVS) = MANDATORY

Question 26

What does PS1-2 relate to?

Answer 26

PS 1 – Compliance with standards (where a written valuation is provided) PS 2 – Ethics, competency, objectivity and disclosures

Question 27

What does VPS1-5 relate to?

Answer 27

VPS 1 – Terms of Engagement (scope of work) VPS 2 – Inspections, investigations and records VPS 3 – Valuation Reports VPS 4 – Bases of Value, assumptions and special assumptions VPS 5 – Valuation approaches and methods

Question 28

What do VPGAs relate to?

Answer 28

VPGA 1 – Valuation for inclusion in financial statements VPGA 2 – Valuation of interests for secured lending VPGA 3 – Valuation of businesses and business interests VPGA 4 – Valuation of individual trade related properties VPGA 5 – Valuation of plant and equipment VPGA 6 – Valuation of intangible assets VPGA 7 – Valuation of personal property, including art/antiques VPGA 8 – Valuation of real property interests VPGA 9 – Identification of portfolios, collections and groups of properties VPGA 10 – Matters that may give rise to valuation uncertainty

Question 29

What type of advice does the Red Book cover?

Answer 29

Valuation advice

Question 30

If you provide preliminary advice / draft valuation report, what should you state in writing to your client?

Answer 30

When providing preliminary advice or a draft valuation report you must state in writing that: - the opinion is provisional and subject to completion of the final report - the advice is provided for the client’s internal purposes only and - any draft is on no account to be published or disclosed. - If any matters of fundamental importance are not reflected, their omission must be declared

Question 31

What type of valuations might be relied upon by a third party?

Answer 31

- Secured lending valuations - Any valuation that expressly outlines this in the terms of engagement

Question 32

What is the definition of Market Rent?

Answer 32

Market Rent the estimated amount for which an interest in real property should be leased on the valuation date between a willing lessor and a willing lessee on appropriate lease terms in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion’

Question 33

What is the definition of Market Value?

Answer 33

Market Value the estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion’

Question 34

What is the definition of investment value?

Answer 34

Investment Value The value of an asset to the owner or a prospective owner for individual investment or operational objectives

Question 35

What is the definition of fair value?

Answer 35

Fair Value (as defined in IFRS): The price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date

Question 36

Does the RICS recognise a difference between fair value and market value?

Answer 36

The RICS doesn’t believe there is a difference between fair value and market value. Fair value is working off the assumption that the property/land owner isn’t going to sell. Not influenced by market forces.

Question 37

What is a net initial yield?

Answer 37

Net Initial Yield - the current annualised rent, net of costs, expressed as a percentage of capital value

Question 38

What is the difference between an assumption and a special assumption?

Answer 38

- A special assumption is a supposition that is taken to be true and accepted as fact, even though it is not true - An assumption is something that would be reasonable to assume is true

Question 39

What sources of information would you consider when preparing a valuation report?

Answer 39

- Transactional Data – information from transactions that have actually taken place in the market - Market Data – market reports from researchers or analysts - Other sources - indexes

Question 40

What is the hierarchy of evidence?

Answer 40

Set out in the RICS Guidance Note: Comparable Evidence in Real Estate Valuation (2019) Hierarchy of evidence 1. Category A – direct comparables - All types of relevant transactional comparable evidence 2. Category B – general market data - can provide guidance rather than a direct indication of value 3. Category C – other sources – Other data that may indicate value

Question 41

If you have previously valued an asset, do you need to make any additional disclosures and what might they be?

Answer 41

If valuing an asset that you have previously valued you must make the following disclosures in the terms of engagement, in the report, and in any published reference to the valuation: - the relationship with the client and previous involvement - rotation policy - time as signatory - proportion of fees

Question 42

What is a rotation policy?

Answer 42

Rotation policy relates to where the RICS member has provided a series of valuations over time; familiarity with either the client or the asset valued could lead to the perception that the member’s independence and objectivity has been compromised RICS recommends rotating valuers at least every seven years

Question 43

What does time as signatory refer to?

Answer 43

Time as signatory means how long the RICS member and firm undertaking the valuation have been signatory to valuations for the same purpose and client

Question 44

If your firm is too small to have a rotation policy or valuation panel, what else can you do to ensure objectivity?

Answer 44

You can arrange for the valuation to be periodically reviewed at intervals no greater than seven years by another RICS member to demonstrate that objectivity is being maintained

Question 45

When might a conflict of interest exist in relation to a valuation instruction?

Answer 45

- acting for the buyer and the seller of a property or asset in the same transaction - acting for two or more parties competing for an opportunity - valuing for a lender where advice is also being provided to the borrower

Question 46

What must be included in your terms of engagement / valuation report?

Answer 46

The terms of engagement must set out the following: - Identification – of the valuer, the client, any other intended user - Property – set out the assets and liabilities being valued - Purpose – of the valuation - Basis – of value - Date – of valuation - Nature and Extent – of the valuer’s work - Sources of Information – relied upon - Assumptions and Special Assumptions – that have been made - Fee – basis on which the fee will be calculated - Complaints Handling Procedure - Insurance – any limitations on liability and the PI cover in place

Question 47

Where are the requirements for terms of engagement covered in the Red Book?

Answer 47

Terms of Engagement (scope of work) are set out in VPS 1

Question 48

What is a restricted valuation service and can you provide one?

Answer 48

A restricted valuation service is a where there are restrictions on the information available or the nature of the valuation assignment. A restricted valuation service may be requested by a client because: - Requirements for a short timescale may limit the ability to inspect the property to verify facts - the request may be for a valuation based on the output of an automated valuation model You can provide one if the restriction is reasonable, with regard to the purpose for which the valuation is required If you believe that it is not possible to provide a valuation even on a restricted basis the valuation should be declined

Question 49

How do you deal with limitations on inspection or analysis?

Answer 49

Any limitations or restrictions on the inspection, inquiry and analysis for the purpose of the valuation assignment must be identified and recorded in the terms of engagement and also in the report

Question 50

Can you revalue a property without inspecting?

Answer 50

You can revalue a property without re-inspecting if the valuer is satisfied that there have been no material changes to the physical attributes of the property, or the nature of its location, since the last assignment

Question 51

What is an internal valuer?

Answer 51

A valuer who is in the employ of either the firm that owns the assets, or the accounting firm responsible for preparing the firm’s financial records

Question 52

Can an external valuer provide an internal purposes valuation?

Answer 52

Yes – an external valuer can provide valuations for internal purposes only without liability and without communication to a 3rd party. When this happens, the need for the terms of engagement and written advice to be absolutely clear about non-disclosure to third parties, and about the exclusion of liability, becomes even more crucial.

Question 53

What happens if market conditions change between the valuation date and report date?

Answer 53

If there has been a material change in market conditions, or in the circumstances of a property, asset or portfolio, between the valuation date and the date of report, the valuer should draw attention to this.

Question 54

Is special value from a special purchaser reflected in MV?

Answer 54

Market Value ignores any price distortions caused by special value (an amount that reflects particular attributes of an asset that are only of value to a special purchaser)

Question 55

What is the Valuer Registration Scheme?

Answer 55

Valuer Registration is a risk monitoring and quality assurance programme which checks compliance with the RICS Red Book

Question 56

Are there any instances where VPS 1-5 of the Red Book may not apply?

Answer 56

In the following instances valuers must state that the valuation was not performed in accordance with the International Valuation Standards A – agency/brokerage valuations (giving investors indication of value) S – statutory function valuations (tax purposes) I – internal strategy purpose valuation A – anticipation of giving evidence as an expert witness N – negotiations/litigation

Question 57

When would you use EUV?

Answer 57

You would use Existing Use Value when undertaking a depreciation replacement cost valuation

Question 58

What is the definition of EUV?

Answer 58

Existing Use Value – the value of property or land in its’ current form

Question 59

What additional criteria apply to secured lending valuations?

Answer 59

1. More Detailed Conflict Avoidance 2. Additional reporting requirements

Question 60

What is a regulated purpose valuation?

Answer 60

Regulated Purpose Valuation – a valuation relied on by 3rd parties who have not commissioned the valuation and are subject to valuation monitoring Regulated Purpose Valuation Includes: 1. Financial Statements 2. Stock Exchange Listings 3. Takeovers and Mergers 4. Collective Investment Schemes 5. Unregulated Property Unit Trusts

Question 61

What is a yield?

Answer 61

Yield - a measurement of future income on an investment. It is generally calculated annually as a percentage, based on the asset's cost or market value

Question 62

What is a reversionary yield?

Answer 62

Reversionary Yield - the anticipated yield to which the initial yield will rise (or fall) once the rent reaches the estimated rental value

Question 63

What is an equivalent yield?

Answer 63

Equivalent Yield - the average weight between your reversionary and net initial yield (assuming rent is paid quarterly in advance)

Question 64

What is a nominal equivalent yield?

Answer 64

Same as equivalent yield but you are assuming that your rent is paid annually in arrears

Question 65

What is WAULT?

Answer 65

WAULT – Weighted Average Until Lease Termination  when you have multiple tenants in a building and want to know the time until termination

Question 66

What purchaser’s costs do you deduct from a valuation?

Answer 66

all out-of-pocket costs and expenses incurred by the Purchaser Agents Fee = 1% Legal Fees = 0.8% SDLT + VAT = 5%

Question 67

How would you value a property in uncertain market conditions – does the Red Book give any guidance?

Answer 67

VPGA 10 – provides guidance on matters that may give rise to material valuation uncertainty You would value the property and if appropriate draw attention to, and comment on, any issues affecting the degree of certainty, or uncertainty, of the valuation

Question 68

What is the difference between a growth explicit and a growth implicit yield?

Answer 68

Growth explicit yield – does not account for rental growth e.g reversionary yield Growth implicit yield – does account for rental growth e.g All Risks Yield

Question 69

How would you value an over-rented investment property?

Answer 69

Core and Top Slice Approach - Property is Over Rented - Workout the market rent and establish what proportion of your current income is over-rented - Split out the under rented and over-rented income streams - Apply two different yields --> higher yield to the over rented, lower yield to the under rented - Capitalise the under rented into perpetuity (assuming that the property will always be able to achieve the market rent) - Capitalise the over rented until lease expiry at which point you assume the property will revert to market rent

Question 70

How would you value an under-rented investment property?

Answer 70

Term and reversion Approach - Value the rent until lease end capitalising using an all risks yield - Capitalise the market rent into perpetuity using a reversionary yield

Question 71

What is the Pereira Gray report and what does it set out?

Answer 71

The Pereira Gray report is an independent valuation review of the RICS standards and guidance. 3 over-arching Recommendations of the report are: - Creation of a dedicated, independently led valuation regulatory quality assurance panel, under the jurisdiction of the RICS Standards and Regulation Board -The creation of a formal Valuation Compliance officer role within regulated valuation providers - encouraging the use of DCF’s rather than Core and Top Slice and Term and Reversion for investment valuations because DCF’s take into account rental growth

Question 72

What would you do if comparable evidence was limited?

Answer 72

A lack of comparable evidence should not prevent a valuation from being undertaken If there is a lack of comparable evidence: - Search further afield across wider range of indicators or indirect evidence e.g national economic data - Comment on any material uncertainty

Question 73

What is a Discounted Cash Flow (DCF)?

Answer 73

Discounted Cash Flow - A valuation model that seeks to determine the viability and investment value (or worth) of a real estate investment property by examining its future net income or projected cash flow from the investment and then discounting that cash flow to arrive at an estimated current value of the investment.

Question 74

When would you use a DCF?

Answer 74

- You would use a DCF to account for more complex assumptions accounting for a potential investors’ timings and cash flow requirements

Question 75

What are the advantages of a DCF?

Answer 75

Advantages: - Able to model complex assumptions e.g specific client or funding requirements and development timings - Growth explicit you can apply your own specific growth rate to a DCF model - Increased accuracy as they tend to be less generic

Question 76

What are the disadvantages of a DCF?

Answer 76

Disadvantages: - Very sensitive to changes in assumptions - Requires a large number of assumptions - Time consuming - Not always needed on straightforward project structures

Question 77

What is a years purchased multiplier?

Answer 77

The multiplier of the net annual income to determine the capital value and it is useful to obtain the capital value of the property

Question 78

What is present value?

Answer 78

the sum of the discounted values of a net cash flow, including all inflows and outflows excluding the initial outflow, where each receipt/payment is discounted to its present value at a specified discount rate

Question 79

How does market value differ to investment value/fair value?

Answer 79

- Market Value is accounting for market forces - Investment and Fair Value not influenced by market forces

Question 80

What is intangible goodwill?

Answer 80

Intangible Goodwill - an asset (an asset that's non-physical but offers long-term value) which arises when another company acquires a new business e.g brand loyalty

Question 81

What is turnover?

Answer 81

Turnover - amount of money taken by a business in a particular period

Question 82

What is gross profit?

Answer 82

Gross Profit - the profit a business makes after subtracting all the costs that are related to manufacturing and selling its products or services

Question 83

What is net profit?

Answer 83

Net Profit - actual profit after working expenses not included in the calculation of gross profit have been paid

Question 84

What is Fair Maintainable Turnover?

Answer 84

Fair Maintainable Turnover - the level of trade that a 'reasonably efficient operator' would expect to achieve on the assumption that the property is in good repair and suitably equipped

Question 85

What is a Reasonably Efficient Operator?

Answer 85

assumes that the market participants are competent operators, acting in an efficient manner, of a business conducted on the premises

Question 86

Do RICS provide any guidance on RLVs or valuing development property?

Answer 86

RICS Guidance Note Valuation of Development Property (2019): - Applies to all valuations of development property - Should be read and applied in conjunction with RICS Valuation – Global Standards 2022 - This guidance note supplements the guidance set out in IVS 410

Question 87

What is residual land value?

Answer 87

Residual Land Value - the amount remaining once the gross. development cost of a project is deducted from its gross development value (GDV) and an appropriate return has been deducted

Question 88

What is a development appraisal?

Answer 88

Development Appraisal – the assessment of viability for development land or a development opportunity

Question 89

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

Answer 89

- With a development appraisal you have a known land value whereas with a residual valuation you are trying to determine the land value - Development appraisals are not red book compliant

Question 90

How do you calculate GDV?

Answer 90

Determine market rent/market value of completed development using comparable evidence - capitalise the income using all risks yield

Question 91

What are typical finance costs?

Answer 91

4-10% of GDV

Question 92

What do holding costs typically include?

Answer 92

Property Management Fees Council Tax Capex and Opex

Question 93

Give me an example of a good covenant and how this might impact a valuation.

Answer 93

A good covenant would be a large international company e.g Google and Apple A good covenant provides a greater security of income and would provide an increased market value.

Question 94

How would you distinguish limitations on liability in your valuations?

Answer 94

You would set out any limitations of liability very clearly within your Terms of Engagement

Question 95

What relevance does Hart v Large have on your valuation practice?

Answer 95

The Hart v Large case emphasises the importance for surveyors of: - Being clear and advising clients on the survey level and scope of inspection, limitations and caveats - Recommending justifiable further investigation - Considering whether any new information provided after inspecting or reporting affects their original advice, and updating their advice if it is justified to do so

Question 96

What is the SAAMCO cap?

Answer 96

SAAMCO Cap - An important principle in the common law of damages, which ensures that surveyors can only be liable for the losses they can properly be said to have caused

Question 97

Under the SAAMCO cap, is a valuer liable for losses due to a downturn in the market?

Answer 97

No - surveyors can only be liable for the losses they can properly be said to have caused

Question 98

What would you do if you received a notice of a PII claim from a client or their solicitor?

Answer 98

I would acknowledge the receipt of the claim and pass it on to our legal team to seek further advice on the appropriate next steps.

Question 99

Explain what you understand by the term, margin of error.

Answer 99

Margin for error is a degree of deviation from a correct or exact value or target – accepted margin of error is between 10% either way

Question 100

In a scenario where rents are static and the capital value increases, would you expect yields to increase or decrease?

Answer 100

NIY – would decrease