PE Valuation - Investment Method

Question 1

When is the investment method used?

Answer 1

For income producing property, i.e. an investment

Question 2

What is a yield?

Answer 2

Annual return on investment expressed as % of capital value

Question 3

What is an All Risks Yields (ARY)?

Answer 3

Remunerative rate of interest used in the conventional valuation of freehold and leasehold interests, reflecting all the prospects and risks attached to a particular investment

Question 4

What is an equivalent yield?

Answer 4

Weighted average of initial and reversionary yields

Question 5

What is a Net Initial Yield (NIY)?

Answer 5

Yield based on initial income and adjusted for purchaser’s costs

Question 6

What is a true yield?

Answer 6

Calculated quartlery in advance

Question 7

What is an equated yield?

Answer 7

Discount rate which needs to be applied to the flow of income expected during the life of the investment so that the total amount of income so discounted at this rate equals the capital outlay

Question 8

What are traditional valuation methods?

Answer 8

Term and Reversion
Hardcore and Topslice

Question 9

Do T&R and Hc&Ts use growth implicit yields?

Answer 9

Yes

Question 10

What do you typically use a term and reversion for?

Answer 10

Under-rented investments

Question 11

What is a reversionary freehold?

Answer 11

An investment where the rent passing is below open market rental value

Question 12

What are key issues when using a hardcore and topslice valuation for an over-rented investment?

Answer 12

Double counting
Topslice is highly geared
Arbitrary division of income
Subjective adjustments
Hard to build in complex circumstances or voids

Question 13

How could you value a leasehold property?

Answer 13

Dual rate (with a sinking fund)
Single rate
DCF

Question 14

When might you chose to use a DCF?

Answer 14

Complex investment
Financial modelling
Adapt to individual investment requirements
Lack of comparable evidence
Assess investment value to assist in buy/sell decision/selection between alternative investments

Question 15

What is the Net Present Value (a type of DCF analysis)?

Answer 15

Present value of all future expected income and capital flows, discounted at the investor’s target or required rate of return

Question 16

What is the Internal Rate of Return (IRR) (a type of DCF analysis)?

Answer 16

Discount rate at which, when applied to all future expected income and capital flows, equates the price with the PV of these discounted income flows (i.e. NPV = 0)

Question 17

Is a DCF growth explicit or implicit?

Answer 17

Explicit

Question 18

What does a positive NPV indicate?

Answer 18

Rate of return hgher than the discount rate is being yielded

Question 19

What are the problems with a DCF?

Answer 19

Subjective
A lot of assumptions are made
Potential for double counting (e.g. building break option into cash flow and discount rate)
Not necessarily based on comparable evidence

Question 20

How do you calculate exit value in a DCF?

Answer 20

Apply a YP in perp (NIY) rather than an equated yield

Question 21

How could you choose a discount rate for DCF?

Answer 21

Risk-free rate + risk premium (market and specific property risk)

Investor’s target discount rate

Question 22

What is correct in relation to a risk premium?

Answer 22

Market risk (systematic) - illiquidity upon sale, failure to meet forecast rental growth and yield shift, risk of obsolescence through structural change, legislative risk

Specific property risk (unsystematic) - covenant risk, void risk, cost of ownership and management, I ensure structures

Question 23

What is the risk free rate generally based on?

Answer 23

Gross redemption yield on a medium-dated government gilt

Question 24

How can you produce a DCF?

Answer 24

By hand, spreadsheet, software e.g. Argus