Investment Method

Question 1

Describe the investment method

Answer 1

• Used when there is an income stream
• rental income is capatalised to produce cap value
• Conventional method assumes growth implicit val approach
• implied growth rate is derrived from the cap rate

Question 2

What is the conventional method?

Answer 2

Rent received, or Market Rent multiplied by the years purchase = Market Value

Question 3

What is a yield

Answer 3

a
A yield is a measure of investment return, expressed as a percentage of capital invested. Formula is Income / (Price x 100).

Question 4

What is a year’s purchase?

Answer 4

A Years purchase shows us how many years would be required for the income to repay the purchase price. It is calculated by dividing 100 by the yield.

Question 5

Define Equivalent Yield

Answer 5

The weighted average yield between the initial and reversionary yields.

Question 6

All Risks Yield

Answer 6

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 the investment.

Question 7

Define Nominal Yield

Answer 7

Initial yield assuming rent is paid in arrears

Question 8

Define True Yield

Answer 8

Assumes rent is paid in advance not in arrears

Question 9

What is the difference between a Gross & Net Yield

Answer 9

A gross yield is not adjusted for purchaser’s costs, e.g. during an auction purchase. A net yield is adjusted for purchaser’s costs.

Question 10

What is a running yield?

Answer 10

The yield at a moment in time.

Question 11

What is a term and reversion valuation, when is it used, and can you draw it?

Answer 11

Term and reversion methodology is used for reversionary assets (ERV>Passing). The term is valued until break / review at initial yield, the reversion capitalised into perp at the reversionary yield.

Question 12

In what situation would your yield between the term and reversion reflect less risk?

Answer 12

When it is indexed linked. You have an idea of where the reversion is going to go to.

Question 13

What method of valuation do you use when a property is over rented?

Answer 13

You use the Layer / Hardcore Method.

The income stream will be divided horizontally.

The bottom slice is the market rent while the top slice is the rent passing less market rent until the next lease event.

A higher yield is applied to the top slice to reflect the uncertainty and risk in achieving the market rent.

Question 14

What is the new RICS guidance on DCF?

Answer 14

This is the RICS Practice Information on Discounted Cash Flows Valuations - November 2023?

Question 15

What is new dcf guidance in response to?

Answer 15

The information is in response to the RICS’s independent review of real estate investment valuations which was overseen by then Wellcome Trust chief executive Peter Pereira Gray in January 2022.

His 13 recommendations called for more oversight over and stricter rules governing property valautions.

Question 16

What was one of the main changes in DCF guidance?

Answer 16

Shift from estimating the ‘exchange price’ to values based on future income calculated using discounted cash flow.

Question 17

What is a DCF?

Answer 17

A DCF is a growth explicit valuation which calculates an investments value based on the ability to receive a predicted future cash flow.

Question 18

What is an alternative definition of a DCF?

Answer 18

A DCF is a growth explicit method of valuation that involves projecting estimated cash flows over an assume holding period with an exit value at the end of this period.

The cash flow is then discounted back to the present day to reflect the perceived level of risk.

Question 19

When would you use a DCF for a valuation?

Answer 19

Where the project cash flows are explicitly estimated over a finite period such as
- Short leasehold interests and properties with income voids.
- Phased development projects.
= Some ‘Alternative’ investments.

Question 20

What is the methodology to find MV via DCF?

Answer 20

Estimate the cash flow, estimate the exit value, select a discount rate, discount cash flow.

The value is the sum of the completed discounted cash flow to provide the NPV

Question 21

Define NPV

Answer 21

Net Present Value = sum of all the discounted cash flows of the project.

Can be used to determine viability of an investment given a certain level of desired return

Question 22

Define IRR

Answer 22

Internal rate of Return,
“The rate at which all future cash flows must be discounted to produce an NPV of 0”

Question 23

What is an IRR?

Answer 23

IRR is a measure of the profitability of an investment over time.

It represents the discount rate at which the net present value (NPV) of all cash flows from the investment equals zero.

Question 24

How is the IRR calculated?

Answer 24

1. Input current MV as a negative cash flow
2. Input projected rents over holding period as a positive value
3. Input projected exit value at end of term assumed as positive value
4. IRR is the rate chose which provides a NPV of 0
5. If NPV is more than zero, then target rate of return is met.