01. Valuations Flashcards
Structure of the Redbook
- Glossary
- PS1 & PS2 (Professional Standards)
- VPS x 5 (Valuation Performance Standards)
- 10 Global Valuation Practice Guidance Applications
Commencing an Instruction
1) Competence – Skills, Understanding & Knowledge
2) Independence
3) Terms of Engagement
Methods of Valuation
- Comparable
- Investment
- Profits
- Residual method
- Depreciated Replacement Cost (DRC)
What does a positive NPV imply?
- The target rate of return yielded by the investment is greater than the target rate
- Sound investment
What does a negative NPV imply?
- The target rate of return yielded by the investment is less than the target rate
- Investment not viable at the required rate of return
When adjusting comparables, what are the most important elements to consider?
i. Age and condition
ii. Specification and layout
iii. Efficiency and adaptability
iv. Legal
v. Limitations on use
vi. Location Size
vii. Transaction Date
What is an All Risks Yield?
The remunerative rate of interest used in the valuation of fully let property let at market rent reflecting all the prospects and risks attached to a particular investment.
What are the different valuation approaches? Which method relates to which approach?
- Income approach - converting future cash flows into a capital value (i.e. Investment, Residual and Profits methods)
- Cost approach - Reference to the cost of the asset (i.e. DRC method)
- Market approach - using the comparable evidence available (i.e. Comparable method)”
What is a Yield?
A measure of investment return, expressed as a percentage of capital invested
How is a Yield calculated?
A yield is calculated by income divided by price x 100
How is YP calculated?
A Years Purchase is calculated by dividing 100 by the yield
What does the term Years Purchase mean?
Years purchase is the number of years required for an assets income to repay its purchase price.
What risk should be considered when determining a yield?
- Quality of location
- Quality of covenant
- Use of the property
- Lease terms
- Obsolescence - what is the likely future rate?
- Voids - what is the risk?
- Security and regularity of income
- Liquidity - ease of sale
- Prospects for rental and capital growth
What is the definition for an All Risks Yield?
The remunerative rate of interest used in the valuation of fully let property let at market rent reflecting all the prospects and risks attached to a particular investment.
What is the difference between a DCF and an All Risks Yield?
The DCF approach separates out and explicitly identifies growth assumptions rather than incorporating them within an All Risks Yield.
What is a Net Present Value?
Present value of all future expected income and capital flows, discounted at the investor’s target or required rate of return
What can a Net Present Value be used for?
A NPV can be used to determine if an investment gives a positive return against a target rate of return
What is shown when an NPV is positive?
When the NPV is positive, the investment has exceeded the investor’s target rate of return
What is shown when an NPV is negative?
When the NPV is negative, the investment has not achieved the investor’s target rate of return
What is an Internal Rate of Return?
It is the discount rate which produces a Net Present Value of zero when applied to the asset’s cash flow
How can you calculate an IRR if you are not using software to assist you?
If the valuer does not have a software programme to calculate the IRR then linear interpolation can be used to estimate the IRR
What is the basic principle of the profits method of valuation?
Basic principle is that the value of the property depends upon the profit generated from the business, not the physical building or location.
What does EBITDA stand for? (In relation to Profits Method Valuations)
earnings before interest, taxation, depreciation and amortisation (the adjusted net profits)
What is the difference between a development appraisal and a residual valuation?
A residual valuation is a financial method for calculating the purchase price of a piece of land. A Development appraisal is a holistic approach looking at a scheme’s feasibility, of which a residual valuation may form a specific part.
What is the key RICS Guidance on the Depreciated Replacement Cost (DCR) Method of Valuation?
Depreciated Replacement Cost Method of Valuation for financial reporting 1st edition, November 2018
How do you establish a Yield?
In finance, the Capital Asset Pricing Model (CAPM) is a model used to determine a theoretically appropriate required rate of return of an asset, to make decisions about adding assets to a well-diversified portfolio. Index Linked BONDS.
Difference between IRR and All Risks Yield?
The IRR is SUBJECTIVE – investors required return.
What are the problems with a DCF?
i. Subjective
ii. A lot of assumptions are made
iii. Potential for double counting (eg building break option into cash flow and discount rate)
iv. Not necessarily based on comparable evidence
What is the risk free rate generally based on?
Gross redemption yield on a medium-dated government gilt
What is the basic process of undertaking a Residual Land Valuation?
Gross Development Value (GDV) - Costs - Developer’s Profit = Land Value
What is GDV?
Market Value of the proposed development assessed on the special assumption that the development is complete as at the date of valuation in the market conditions prevailing at that date
When is DRC used?
Specialised Property
‘A property that is rarely, if ever, sold in the market, except by way of a sale of the business or entity of which it is part, due to the uniqueness arising from its specialised nature and design, its configuration, size, location or otherwise.’
Three principal types of depreciation allowance, or obsolescence,
a. physical deterioration
b. functional obsolescence and
c. economic obsolescence
Depreciation
i. Straight Line Straight-line depreciation assumes the same amount is allocated for
depreciation for each year of the estimated life.
ii. Reducing Balance The reducing balance method of depreciation assumes a constant
percentage rate of depreciation from the reducing base. The reduction of the balance at the end of each period by a fixed proportion of itself creates a sagging depreciating value curve over the life of the asset. This method effectively ‘compounds’ the total depreciation. This may match reasonable expectations of declining value over time better than the straight-line method.
iii. S Curve
How does the Red Book describe the DRC method?
Current cost of replacing an asset with its modern equivalent asset less deductions for physical deterioration and all relevant forms of obsolescence and optimisation
What is the term for the cost to replace the asset?
Gross Replacement Cost
How do you assess site value?
Least expensive site suitable and appropriate for proposed operations
On what basis do you assess the cost to replace the building?
Modern equivalent
How does a reinstatement cost assessment differ from a DRC?
Doesn’t include land or depreciation
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.’
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.’
Investment Value
‘the value of an asset to a particular owner or prospective owner for individual investment or operational objectives.’
Equitable Value
‘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.’
Departures from Redbook
(PS1)
i. Agency or brokerage advice (not a purchase report)
ii. Acting as an expert witness
iii. Statutory functions
iv. Internal purposes
v. In the course of negotiations/litigation
Which of these do you need to satisfy in order to be competent to provide a valuation?
i. Appropriate academic/professional qualifications, demonstrating technical competence
ii. Membership of a professional body, demonstrating a commitment to ethical standards
iii. Sufficient current local, national and international (as appropriate) knowledge of the asset type and its particular market, and the skills and understanding necessary
iv. Compliance with any country or state legal regulations governing the right to practise valuation
v. Where applicable, compliance with the RICS Valuer Registration (VR) requirements
When would fair value generally be used?
Financial statement valuations
What is measurement date?
Measurement date, as per the International Account Board Standards, is the current price that should be achieved at the date in question i.e. the value as at todays date – reflective of the valuation date.
Departures from the Redbook
Agency Expert Witness Statutory functions Internal purposes Litigation
Basic Assumptions
Title
Repair
Services
Planning
WACC
Weighted Average Cost of Capital
What does VPGA 2 relate to?
Secured Lending
What additional criteria apply to secured lending valuations?
That the valuer has had no previous, current or anticipated involvement with the borrower, or prospective borrower, the asset to be valued or any other party connected with a transaction for which the lending is required (for 24 months, or longer if requested)
What does the Redbook say in relation to sustainability?
Reflect, don’t lead markets
What sustainability issues could you reflect in your advice?
Green design features Life cycle materials Embodied carbon Energy efficiency Waste management Location Accessibility
What is the difference between fair value and market value?
1) Measurement date
2) allowance for marketing period
RICS definition of Fair Value
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
What is a DCF?
It is a growth EXPLICIT investment method of valuation
What is the difference between DCF and the All Risks Yield?
The DCF approach separates out and explicitly identifies growth assumptions rather than incorporating them within an All Risks Yield.
