Valuation - Level 2 Flashcards
1
Q
Why do we value property?
A
- Purchase/Sale
- Secured Lending
- Financial Statements (E.g. Accounts)
- Statutory Purposes
- Internal Purposes
2
Q
The RICS Valuation – Professional Standards (Global and UK) or the Red Book was originally produced in January 2014 – what has this been subsequently split into in 2017?
A
- RICS Valuation – Global Standards (2017)
- RICS Valuation – Global Standards: UK National Supplement (2019)
3
Q
The RICS Valuation – Global Standards & RICS Valuation – Global Standards: UK National Supplement have been updated several times, what is the most current edition of both documents published?
A
- RICS Valuation – Global Standards (2017) was most recently updated in December 2024, to be effective for valuation dates from 31st January 2025 and thereafter.
- RICS Valuation – Global Standards: UK National Supplement (2019) was most recently updated in October 2023, effective from 1st May 2024 and thereafter.
4
Q
When were and what were the reasons to the most recent updates in The RICS Valuation – Global Standards & RICS Valuation – Global Standards: UK National Supplement?
A
- RICS Valuation - Global Standards was updated in December 2024 to align with the new International Valuation Standards (IVS) effective from January 2025. There has been extensive editing of the text but the essence has not changed.
- RICS Valuation - Global Standards: UK National Supplement was updated in October 2023, effective from May 2024 to align with global 2022 update.
5
Q
What is another name for RICS Valuation – Global Standards?
A
The Red Book
6
Q
What is the contents of the Red Book?
A
Part 1: Introduction
Part 2: Glossary
Part 3: Professional Standards (PS) (Mandatory)
Part 4: Valuation Technical and Performance Standards (VPS) (Mandatory)
Part 5: Valuation Applications (VPGA) (Advisory)
Part 6: International Valuation Standards 2017
7
Q
Outline Part 3 of the Red Book?
A
Part 3: Professional Standards (PS) (Mandatory), is broken down into:
- PS 1 = Compliance with standards where a written valuation is provided
- PS 2 = Ethics, Competency, objectivity and disclosures
8
Q
Outline Part 4 of the Red Book?
A
Part 4: Valuation Technical and Performance Standards (VPS) (Mandatory), is broken down into the following since the 2024 update:
VPS 1 Terms of engagement (scope of work)
VPS 2 Bases of value, assumptions and special assumptions (was VPS 4)
VPS 3 Valuation approaches and methods (was VPS 5)
VPS 4 Inspections, investigations and records (was VPS 2)
VPS 5 Valuation models (new)
VPS 6 Valuation reports (was VPS 3)
9
Q
Outline Part 5 of the Red Book?
A
Part 5: Valuation Applications (VPGA) (Advisory), is broken down into the following, since the most recent update:
VPGA 1 Valuation for financial reporting
VPGA 2 Valuation for secured lending
VPGA 3 Valuation of businesses and business interests
VPGA 4 Valuation of trade related properties
VPGA 5 Valuation of plant and equipment (including infrastructure)
VPGA 6 Valuation of intangible assets
VPGA 7 Valuation of arts and antiques
VPGA 8 Valuation of real property interest
VPGA 9 Valuing portfolios and group of assets
VPGA 10 Material valuation uncertainty (MVU)
VPGA 11 Relationship with auditors (new)
10
Q
What is the purpose of the Red Book?
A
“To impose mandatory obligations for competence, objectivity and transparency and to establish a framework of uniformity and best practice in valuation”
NOTE: The Red Book does not instruct on how to value
11
Q
What does the Red Book not do?
A
A) Instruct on how to value
B) Prescribe a particular report format
C) Override specific mandatory standards in individual jurisdictions
12
Q
What is some statutory due diligence that needs to be taken when undergoing a valuation?
A
Examples of Statutory due diligence are (probs don’t need to know all of them):
- Asbestos Register
- Business Rates / Council Tax
- Contamination
- Equality Act Compliance
- EPC
- Flood Risk
- Fire Safety Compliance
- Health and Safety Compliance
- Highways
- Legal Title
- Planning History / Compliance
13
Q
What should you do before anything as standard practice when asked to undergo a valuation?
A
- Check you’re competent enough to do the valuation
- Check if there are any conflicts of interests
14
Q
Outline the process of a typical Red Book Valuation/ File Contents?
A
- As yourself am I competent? Do I have the necessary skills / Knowledge /Experience?
- Conflict of Interest (COI) check
- Terms of Engagement
- Inspection notes etc.
- Planning, rating and environmental searches
- Comparables and analysis
- Valuation calculations with rationale
- Report
15
Q
What Valuations are exemptions from the Red Book?
A
PS 1: The Red Book applies to all valuations unless the purpose is specifically listed as an Exception:
- Agency or brokerage work in anticipation of disposal or acquisition instructions
- Acting or preparing to act as an expert witness
- Performing statutory functions
- Purely for internal Purposes
- Preparation for or during negotiations or litigation
NOTE: A Replacement cost for insurance purposes is not a “valuation” - therefore don’t say its an exemption!
16
Q
What should happen if a valuation veers away from Red Book guidance for any reason?
A
- This must be confirmed and agreed with the client as a departure and a clear statement to that effect must be included in the terms of engagement, report , and any published reference to it.
17
Q
What are the main Terms of Engagement?
A
The main Terms of Engagement are:
(a) Identification and status of the valuer
(b) Identification of the client(s)
(d) Identification of the asset(s) or liability(ies) being valued
(f) Purpose of the valuation
(g) Basis(es) of value adopted
(h) Valuation date
(i) Nature and extent of the valuer’s work - including investigations - and any limitations thereon
(k) All assumptions and special assumptions to be made
(o) The basis on which the fee will be calculated
18
Q
What bases of value are included in the Red Book?
A
- Market Value
- Market Rent
- Investment Value (or Worth)
- Fair Value
19
Q
What additional Bases of Value are outlined in IVS 104?
A
- Equitable Value
- Synergistic Value
- Liquidation Value
20
Q
What is the definition of Market Value?
A
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 knowledgably, prudently and without compulsion.
21
Q
What is the definition of Market Rent?
A
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 knowledgably, prudently and without compulsion.
22
Q
What is an arms length transaction?
A
Where there is no connection/relationship between all parties.
23
Q
What is Investment Value?
A
The value of an asset to the owner or a prospective owner for individual investment or operational objectives?
24
Q
What is a special assumption?
A
A special assumption is where an assumption assumes facts that differ from those existing at the valuing date.
E.g.
- Planning consent has or will be granted
- Development completed in accordance with the defined plan and specification
- Property changed in a defined way
- Property is vacant
- Property is let on defined terms
- Synergistic value is created
25
What are the Conventional Valuation Methods?
1. Comparative
2. Investment
3. Residual
4. Profits / Accounts
5. Contractor's / Depreciated Replacement Cost
26
In simple terms, what is the Comparative Method?
- Direct capital or rental comparison
- The primary and most reliable valuation method
26
What is an example of a Contemporary Valuation Technique?
- Discounted Cash Flow (DCF)
27
What similarities must a property have to be considered comparable?
- Physical Characteristics
- Location
- Time Scale
- Use
- Tenure
28
What is zoning?
- Zoning is a valuation technique, NOT a measurement technique.
- Is used to compare retail space having different frontage to depth ratios.
29
What documents are you aware of that advise on the comparable method of valuation?
- RICS Information Paper: Comparable Evidence in Property Valuation (1st Edition, 2012).
30
In brief terms what do you understand the hierarchy of evidence to be?
- The better the evidence, the more weight it will carry.
31
What is the hierarchy of evidence?
1. Open market lettings
2. Lease Renewals
3. Rent Reviews
4. Independent expert's determination
5. Arbitrators Awards
32
What is the Investment Method of valuation?
- Used to value shops, offices, industrial and warehouse properties that are:
- Let with an income stream
- Owner occupied
- Vacant
33
What is the investment method in a basic equation?
- Market Rent (Net of Outgoings) X Years Purchase (YP) = Market Value
34
What is the definition of Yield?
The yield is a measure of investment return expressed as a percentage of capital invested.
35
How do you calculate the YP in perpetuity?
- YP in perpetuity = 100/yield
36
What risk of an investment does the all risk yield take into account?
- The physical characteristics
- The tenants covenant strength
- The unexpired lease terms
- The other lease terms including rent
- Anticipated rental growth (may not have been made explicit in the valuation)
37
Why is the yield also known as the market capitalization rate?
It is the rate at which the market capitalizes the income.
38
What is Gross Initial Yield?
- Rent expressed as a percentage of the purchase price
39
What is Net Initial Yield?
- Rent expressed as a percentage of the gross cost of acquisition
- E.g. Purchase price plus purchaser's costs
- NOTE = If Market Rent is capitalized at a Net Yield, Purchaser's Costs must be deducted to arrive at Market Value
40
What are typical Purchaser's Costs?
- Stamp Duty Land Tax (SDLT)
- Agent's Fees
- Legal Fees
- Non Recoverable VAT on fees
41
What is a reversionary investment?
A reversionary investment is where a property is let at a rent other than the Market Rent.
42
What method would you use if a property was Under-rented?
- Term and Reversion
- Hardcore /Layer
- NOTE = Top-slice income is the anticipated rental increase at review or reversion.
43
What method would you use if a property was Over-rented?
- Block income
- Core income
- NOTE = Top-slice income the overage or froth
44
What is a leasehold interest in terms of valuation?
- Leasehold interests have a value when there is:
- A Profit Rent (Market Rent less rent paid). --> Note: Is top-slice income
- An unexpired term of at least one year
45
How do a freehold reversionary investment and leasehold interest relate to eachother?
- A freehold reversionary investment and leasehold interest with value arise simultaneously.
46
How are leasehold interests valued?
Leasehold interests are valued by capitalizing the profit rent by:
- YP Dual rate
- YP Dual Rate (tax adjusted)
- YP Single Rate
47
What does the YP Dual Rate comprised of?
- The Remunerative Rate
- The Accumulative Rate (sinking fund)
48
What is the residual method of valuation?
- The residual method is used to value land and properties with:
- Development, redevelopment and refurbishment potential
- When it is not possible to value by comparison
49
What equation is used for the residual method?
Value of Completed Development - Development Costs - Developers Profit = Land Value
50
Quantify purchaser's costs in percentage terms?
- Stamp Duty Land Tax = 0% if under £150,000, 2% on next £100,000 and 5% on anything over £250,000
- Agent Fees - 1%
- Legal Fees - 0.5%
- VAT on Fees = 0.3%
- Total for fees (Inc VAT) - 1.8%
50
What is the Profits (Accounts) Method?
The Profits method is used to value leisure property.
- For example:
- Amusement and Theme Parks
- Camping and Caravan Park
- Golf Courses
- Nursing and Care Homes
- Theatres
50
How can you calculate the value using the Profits Method?
Turnover (Net of VAT) - Costs of Generating the Turnover = Net Operating Profit (which is then capitalised)
51
What is the Contractors Method (Depreciated Replacement Cost (DRC)) approach?
- The method of last resort
- Used to value properties which do not usually change hands on the Market other than as part of a sale of the business (Specialised Properties).
- Inclusion in Company Accounts and other financial statements (Asset Valuations)
- Also used to value Non-specialised properties when there is no direct comparable evidence
52
What is a discounted Cash Flow (DCF)?
- Sometimes referred to as a Contemporary Method
- Rental and capital growth are made explicit
- The cash flow is discounted at the investor's target rate of return which is arrived by taking a risk-free rate plus a risk premium
- The risk free rate = the gross redemption yield on UK gilts
- The Risk Premium comprises = Market Risks & Specific Risks
- NOTE = In a conventional investment valuation rental and capital growth are not made explicit but are implicit to the capitalization rate (all risks yield)
53
Who are the international standards Valuation council?
The IVSC are a non- organisation that acts as the global standard setter for the valuation profession, serving the public interest.
54
What is the purpose of the UK National Supplement?
- The UK national supplement supports the Global Red Book for valuations that are subject to UK jurisdiction but does not replace them. (to supplement global valuations standards not substitute them)
- Mainly updated to align it with the 2022 red book, minimal changes.
55
Which Valuations does the red book apply to?
All valuations apart from those that are exceptions.
56
Can you name some valuations that are carried out as statutory functions?
Lease renewal e.g. reporting on rent at lease renewal - see s34 of LL & T Act 1954 to see rent definition
Rating EG if giving a rating valuation there will be legislation to follow
Also compulsory purchase
57
What is the difference between Valuations Technical and Performance Standards (VPS) and Valuations Practice Guidance- Applications (VPGA)?
These are two elements that make up the red book.
Compliance with VPS - Mandatory
Compliance with VPGA - Advisory
58
What are the possible consequences if a Valuer does not comply with VPS?
RICS Disciplinary action for departing from the red book (depends on extent of non-compliance / severity of breach).
Could also be used in negligence against the surveyor. (Possible legal action could be taken by the client)
59
What are the possible consequences if a Valuer doesn’t comply with VPGA?
Could be a contributing factor to be sued, however only guidance so no legal action/ disciplinary action.
More senior people in Workman would agree terms of engagement with the client - if Workman causes a client to lose money, client can sue Workman for professional negligence. Therefore, in valuation terms - if you advise someone to pay too much to buy a property, you could get sued for negligence. Lawyer would ask to see valuation file - will be looking for Red Book compliance.
Even if you comply with Red Book, you could still get sued - could have used poor comparables, could have measured the unit incorrectly etc.
60
Describe how Departure from the Red Book mandatory requirements may be possible?
Easy to get confused between Red Book exception and Red Book departure
Exception = Red Book doesn't apply
Departure = Red Book does apply, but valuer does not comply with mandatory requirements
Can depart if there are special circumstances where it is inappropriate to comply with VPS 1 - VPS 5 and client agrees. EG client says 'just want quick valuation, but not a Red Book valuation' - can't do this, valuer should decline
EG client says 'do valuation without going inside the property' - again, can't do this, valuer should decline
IF there is good reason for not going into the property, then could depart e.g. if you might be met with hostility and violence, say in terms of engagement due to relationship between landlord and tenant I have been instructed not to enter the property- got to be confirmed in terms of engagement and it has got to be reported that this may impact the valuation.
Can only depart if there are circumstances that justify departure
61
Information required when asked 'can you do a valuation?'
Location
Type of property (need to ensure you are competent)
Purpose of valuation (EG if for buying property, need to check whose selling it and ensure that the seller isn't someone you know - need to avoid conflicts of interest)
First thing 'WHAT is it and WHERE is it?'
62
How would you respond to a request to value a property from Pavement only assessment?
Same as external inspection only
Lots of people think this is not a Red Book valuation - it actually is
Usually carried out for a re-valuation (where you/your firm has inspected this property before and there have been no changes since then)
If it is a brand new industrial building and you've got the floor plans you can do it - it's never been occupied so it's fine
HOWEVER if you don't have a copy of the lease or the floor plans and you don't know the area, then you can't proceed
Depends on:
Do you have prior dealings? i.e. have you previously carried out a full inspection of this property?
If it is new instruction, then might be acceptable if you've got sufficient (scaled) floor plans and lease(s)
63
Please name the UK- Specific Bases of Value
Existing Use Value (for social housing)
Project Market Value (For market value marketing period has already occurred - for repossession it would be projected i.e. if it was put on the market today - however this has disappeared from the upcoming UK national supplement).
64
What is the difference between a basis of value and a method of value?
Method of Valuation = the techniques used to arrive at a figure that we would describe with a Basis of Value
Basis Value = Red Book definition of Value (market value, market rent, investment value and fair value)
65
Describe the assumption usually made in producing a valuation?
Title - freehold vs leasehold (assume good title can be shown)
Assume any parts of a property that are covered, are free from defects - i.e. condition is okay
Assume property has full planning permission for existing use
Assume property is free from hazardous substances
Assume property is free from contamination
66
What is a special assumption?
An assumption that assumes facts that differ from those existing at the valuation date.
67
Describe the special assumptions usually made?
If property is vacant, we could assume it is let (and vice versa)
If property is being developed, we could assume development has completed
If property hasn't got planning permission, we could assume planning permission has been granted
68
What do you consider proper marketing?
Exposure to the market in the most reasonable manner (appropriate type and length, advertising to the appropriate target market)
69
What is synergistic Value?
Where the combined value of two or more assets together is greater than the sum of the separate values.
e.g. site A is £100k and site B is £100k
If you merge the sites, the synergistic value is £250k (more than £200k)
70
What is marriage Value?
An additional element of value created by the combination of 2 or more assets or interests where the combined value is more than the sum of separate values. (The additional £50k in the example above - the extra value - often common to split this value between seller and purchaser).
71
What is special value?
An amount that reflects particular attributes of an asset that are only of value to a special purchaser.
72
What is a special Purchaser?
A buyer for whom the asset has special value because of advantages arising from its ownership that would not be available to other buyers in the marker – they may be willing to pay more than market value.
73
When is Market Rent not appropriate as a Basis of value?
Market rent is not suitable for rent reviews - where the actual definitions and assumptions have to be used.
74
When is Fair Value be appropriate Basis of Value?
When valuing for accounting/financial reporting i.e. company accounts (no different to market value, just used when valuing for inclusion in company accounts)
75
What is an asset valuation?
A valuation for financial statements (basis of value is Fair Value)
76
What is the regulated purpose valuation?
Disclosures where the public has an interest or upon which 3rd parties may rely (valuation of which 3rd parties may rely, i.e. for take overs and merges)
77
When is existing use value the valuation basis?
For valuation of operational property - owner occupied properties owed by local and centralised government.
78
When is DRC used in Asset Valuations?
The depreciated replacement cost (DRC) method is used to value owner occupied specialised properties (one that wouldn’t sell with vacant possession only). - i.e. a football stadium without a team.
79
What is the fundamental difference between Market Value and Existing Use Value?
Existing use value is market value, disregarding any alternative use (i.e. assuming it will only be used for the existing use for the foreseeable future).
Market value is the highest and best use of an asset.
80
How many comparables are needed to produce a valuation?
A number are needed to value by comparison as the price in any transaction may be distorted i.e. the property not being subject to proper marketing. As much comparable evidence as possible can help establish trends.
81
Name three situations that can adversely affect the certainty of valuations
When there is an unusual property (in design or location) e.g. very nice office building in middle of an undesirable estate
When there is market volatility e.g. mid-covid pandemic where there is high level of uncertainty / disrupted market
Where we have not carried out usual inspections e.g. not inspected interior of the property and not got the lease to hand
82
Name Types of comparable evidence?
Non-transactional evidence
Transactional evidence
83
What is the longest time period before a valuation date that a transaction could be accepted as being comparable?
The time it takes to become out-of-date will depend on market conditions.
Most recent comparables tend to hold the most weight.
Should be post March 2020 due to COVID-19
84
What do you understand by the expression weighting of comparable evidence?
After gathering comparable evidence a valuer must weight and rank each piece, some may be disregarded.
This is subjective depending on what the valuer thinks.
Attach the greatest weight to those transactions which are most similar to the subject property
85
What is interpolation of comparable evidence?
Calculating or plotting on a graph, a value that lies between two extreme points. This is considered permissible.
86
What is extrapolation of comparable evidence?
Calculating or plotting on a graph, a value outside of two extreme points. This is considered dangerous.
87
What is Zoning?
Rental value of shops are based on NIA it is usually established using zoning. Zoning is not a measurement technique but a valuation technique.
Used to compare retail units with different shapes / different frontage to depth ratios
88
What is a standard Zone depth?
Typically, 6.1m (20ft) but differs in prime retail such as oxford street (9.1m).
The zones are halved back:
Zone A being X
Zone B being X/2
Zone C being X/4- *//*
Remainder being X/8
X/10 – usually used for 1st floors, basements etc.
Where a first floor is used for retail purposes, the Zone A/10
If first floor is non-retail purposes ( e.g. storage) then it is sometimes acceptable to take a rate independent of X
89
How would you assess the market rent of a ground floor unit with a return frontage?
Apply a percentage uplift for the depth of the return (say 5%) depending on pedestrian flow
All of a unit becomes Zone A if both frontages have equal pedestrian flow, could make a reduction for excessive Zone A
A percentage reduction for lack of internal space for shelving and window displays
90
How would assess the market rent of a ground floor with frontages on two roads (through Unit)?
In halving back from both frontages at the same or different zone A rates (different zone A rates are more likely as there is likely to be different footfall on each road).
91
How would you determine market value of an investment property let on internal repairing terms?
Let on internal repairing (IR) terms and the outgoings that need to be deducted are
➢ external repairs
➢ insurance
➢ management
Take rent and deduct for outgoings external repairs, insurance and management to give us the net rent which we would then capitalise.
92
Describe how you have carried out (or would carry out) a Residual Valuation.
(GDV) – (Development costs+ developers profit) = Land value
93
How would you value a green field site with planning permission for a residential development?
The Residual Method - use comparable if possible
94
What costs did you deduct in your residual valuation?
Demolition/site prep
Cost of construction (Building cost)
Construction fees (architects, engineers etc.)
Cost of finance
Contingency to allow for fluctuations in these costs
Agent and legal fees (in disposing the development)
Acquisition costs - Fees and stamp duty land tax on acquisition when you buy the site
(GIVE ANSWER IN THIS ORDER AS IT IS LOGICAL)
95
How did you calculate developers profit in you Residual Valuation?
Developers profit can be calculated by either a percentage of total cost (22-25%) or a percentage of Gross Development Value (15-17%) *Depends upon risk
The riskier the development, the greater the percentage
Would say 'I used 15% because there was only a moderate risk'
96
What are the usual acquisition costs of a development site?
- Stamp duty land tax
- Acquisition agents fees
- Legal fees
- VAT on the agent and legal fees
1.8%= 1% lettings fees 0.5% for sols fees + 20% VAT= 1.8%
97
What are the stamp duty rates?
0% on the first £150K
2% on the next £100K
5% above £250K
For purchases above £250K the SDLT can be calculated from the Gross Acquisition Price net of agent and legal fees.
98
What is a ransom strip?
A strip of land that provides access to another piece of land. Access to the other piece of land can only be made by crossing the ransom strip.
99
What is Ransom Value?
The value attributable the ransom Strip.
100
How would you value a ransom strip?
Would be valued at a percentage of the uplift in value resulting from the owner of the land having access over the ransom strip
(Don't mention 1/3 here unless asked - it is case specific, and 1/3 is just typical).
101
What does Stokes v Cambridge mean to you?
Compulsory purchase case in 1961
A case in which agricultural land was valued as an industrial piece of land as it provided access to an industrial site
It was held that the value of the ransom strip was 1/3 of the uplift in the value of the development land
Since then, 1/3 of the uplift in value for the ransom strip has been accepted as an industry stanard (there is a 1/3 - 2/3 split)
102
What is the profits Method also known as?
Accounts method
103
Name 3 property types that would be valued by the profits method?
Leisure properties:
Arcade,
casinos,
Cinema,
hotels,
golf courses,
theatres
104
Why are certain properties valued by the profits method?
When we can't separate the property from its use - Used to value properties that’s Use/ Nature of business use adds to its value.
105
What valuation checks can be carried out on a valuation produced by the profits method?
Unit prices per seat (e.g. cinemas)
Per Bedroom (e.g. hotels)
106
When is the contractors’ method used in practice?
As a last resort, when no other method can be used.
107
What is another name for the contractors’ method?
Depreciated replacement cost method
108
Explain what is included in a Reinstatement/ Replacement Cost for insurance purposes?
Insure the building so that if it were to be damaged by fire/storm etc - need to know the cost to demolish it, rebuild it in accordance with current regulations, plus professional fees.
Demolition
Shoring up and weather protection of adjoining buildings
Re-building in accordance with current building regulations
Professional fees
109
How would you value a property for which there are no comparables?
Contractors’ method
110
Why is the YP single rate table also known as the Present Value of £1 per annum?
It tells us the PV of £1 to be received each year, for a given number of years
YP tells us present value of annual series of incomes - the further we go into the future, the lower the sum becomes in today's terms
£1 in the future is not worth £1 today - PV of £1 p.a. - discounting each year when it is per annum
111
What are the principle sources of investment?
Three main sources are:
Gilts (UK Government Bonds)
Equities (Shares in Companies)
Property
112
What is a bond investment?
A bond investment has a fixed return for a fixed period at the end of which the capital is repaid
113
What is the major attraction of property over the other two major investment opportunities?
With proactive management you can improve performance (e.g. refurbish units, regear leases). With a gilt or a company you have shares in - you can't improve it's performance easily.
114
What are the major disadvantages of property over the other two major investment opportunities?
Property investment has a higher level of risk and difficulties than investing in gilts etc. therefore an investor will require a higher yield to compensate.
Low liquidity - You can buy/share equities and guilts almost instantly, but with property it takes a long time to get into it
Requires active management (easiest to let FRI)
High transfer costs (agent fees)
Not divisible
115
What would you do if you had to value an investment property but could not find any evidence of yields?
You would construct a yield
Look at gilts, as they are a risk-free investment, and then add a risk premium
Take into account market risks and property risks
Deduct growth (note: no growth if in recession)
116
How is rental and capital growth accounted for in a conventional investment valuation?
It's included in the all risks yield
The greater the growth opportunity, the lower the yield
117
What is a reversionary investment?
A reversionary freehold is an investment that is let at a rent other than Market rent (under-rented or over-rented).
There are two approaches to value a reversionary investment.
Term and reversion
Hardcore/ layer method
118
Explain the process of the term and reversion technique?
We capitalise the passing rent until review or reversion (to market rent)
(Do this, by multiplying the passing rent by the YP for the number of years to the reversion)
We take the market rent to be received at review/reversion and then capitalise that into perpetuity (gives value at that moment in time)
Capitalisation = multiplying by the YP
We then defer it further, at a PV of £1, for the period of the term
The reversion gets capitalised at market rented rate, but the term gets capitalised at a lower rate due to the lower risk (if over-rented, then term would have higher yield and reversion would have lower yield)
Also known as block-income approach (value each block of income)
119
Explain the process of the hardcore/layer technique?
We capitalise the rent passing into perpetuity
We then take the additional rent that we expect to receive at review/reversion and we capitalise that into perpetuity
This gives top-slice value at that moment in time
We need to defer it for the period of the term
The bottom slice is capitalised below market rented rate due to reduced risk, and the top slice is capitalised above this rate to reflect the increased risk
There is risk at review that you won't receive the additional rent (it could be argued that the rent review etc. is not agreed yet so the investment as a whole must have a higher risk attached to it than a market-rented investment).
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What is an initial yield?
the net income (or passing rent) at the date of purchase expressed as a percentage of the Purchase Price
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How would you value an over-rented investment?
Can use either:
Term and reversion
Hardcore or layer
Both blocks and slices would be capitalised at an above market rented rate
Use block income (another name for term and reversion) or core income techniques
Need to capitalise market rent into perpetuity and then capitalise the top-slice income (the over-rented portion) up to review/reversion
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What is a reversionary yield?
the Market Rent expressed as a percentage of the Market Value (or Purchase Price)
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What is the running yield (straight yield)?
Present income expressed as a percentage of market value
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What is top-slice income?
3 examples:
Additional rent expected at review/reversion when under rented
Overage/froth
Leasehold profit rent
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What is a true equivalent yield?
It is the yield, when taking into account that rent is received quarterly in advance (rather than the nominal yield which is generated when rent is received annually in arrears)
(does not affect valuation)
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What is an equivalent yield?
the weighted average of the Initial Yield / Running Yield and the Reversionary Yield
Weighted average = takes into account the importance, rather than treating each item equally
The weighted average is always closer to the reversionary yield than to the initial yield
It can also be described as the internal rate of return from an investment disregarding any rental or capital growth
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What is an equated yield?
It is the overall rate of return, taking into account the growth
It is the true investment yield
It is the discount rate at which the DCF equals the purchase price of the investment
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How is top-slice income valued?
Capitalised above the market rented rates to reflect the increased risk
(i.e. at a higher rate than bottom slice income)
The risk is on receiving the extra proportion of rent (not the rent that we are already receiving)
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How would you value a leasehold interest / ascertain if a premium can be charged for the assignment of a lease?
Only has value if there is a profit rent and an unexpired lease term of more than one year
Answer: I would capitalise the profit rent (the market rent less the rent paid)
If you get asked, can then say, would capitalise via the YP single rate, the YP dual rate, or the YP dual rate tax adjusted.
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What effect does rent received quarterly in advance have on the yield?
It increases it (becomes the true equivalent yield rather than the nominal yield)
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What are the names of the two yields in the YP dual rate? (can come up when discussing assignments).
Accumulative rate
Remunerative rate
Which is the sinking fund rate?
Accumulative rate
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What is the fundamental difference between conventional investment valuation techniques and discounted cash flow techniques?
In conventional investment valuations, growth is implicit in the capitalisation rate (i.e. we do not calculate future rental and capital growth so investor may accept low yield as they are expecting growth)
In a DCF, we make the growth explicit - we calculate what future values are going to be (i.e. we build in the growth and calculate what the future rent/future market value would be)
IN DCF we discount with growth at the invested target rate of return
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How is growth calculated in a discounted cash flow?
We compound it using (1+i)^n or Parry's Amount of £1 Table
(Compound interest is when interest is added to invested cash, and interest is also added to any interest previously paid.)
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How would you arrive at a discount rate when carrying out a discounted cash flow?
UK Government Stock (Gilts) form the basis of yields
Start with risk free rate and add on market risks and property risks
Take risk free rate and add the risk premium
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What is a risk-free rate?
The yield from UK Gilts
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What do you understand by the expression risk premium?
The return over and above Government Stock, that the investor will require
The yield an investor would require that is over the yield from gilts
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Why do property investors require a risk premium?
Because there is more risk and more difficulty investing in property than there is investing in gilts (Government Stock/Government Bonds)
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All people, bank, owner, purchaser want to know the market value for a sale of marketing period of 6 months?
How we ensure a building sells, or for a distressed sale.
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What’s the BOE base rate?
5.25%
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What’s inflation?
Target is 2% - current inflation rate is 4%
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RICS CODE OF MEASURING PRACTICE – measurements:
Gross External Area (GEA)/ IPMS 1
Gross Internal Area (GIA)/ IPMS 2
Net Internal Area (NIA)/ IPMS 3
Industrial and warehouse rents usually based on GIA
Shop rent usually based NIA
Office rents should now be based on IPMS 3 (however, not suitable in all circumstances)
For retail property rent is often expressed ITZA.
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Do you know what the standard floor capacity is?
40 Kilonewton per M2
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How is present value calculated?
By discounting the future cash amount/ property value at the appropriate discount rate .
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What is it called when you speak to letting agents to verify your findings?
Triangulation
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Talk me through how to value an under rented property?
Term and Reversion/Block Income
Capitalise passing rent until reversion – at lower yield as safe
Capitalise reversionary rent into perpetuity, deferred by multiplying by PV £1 for period of term – at higher yield as not yet agreed
Hardcore / Layer
Top slice income = additional rent we expect to receive at review/reversion when under rented
Capitalise passing rent into perpetuity
Capitalise top slice/marginal income into perpetuity, deferred for duration of term
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What does Red Book say we have to do before doing valuation? What next?
- Establish competence, conflict of interest and agree terms of engagement
- Inspect, note limitations, purpose of valuation, basis of value and assumptions/special assumptions
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What are the sources of comparable evidence?
letting boards, speaking with agents, EGI, CoStar Focus, own/office records, Land Registry
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What impact does the tenant paying monthly have on valuation?
The yield would increase to reflect greater risk
