RE Valuation Techniques Flashcards
What are the common purposes of prop vals?
* mortgage security
* determining val of fixed assets for financial stmts
* determining val of improvements for replacement/reinstatement or indemnity insurance purposes
* indication of the investment performance (demonstrating R of invested funds and the details of capital growth)
From a legal perspective, what specific details/sections should a valuation report contain?
Should contain specific dtails i.e. instructions, qualifications, assumptions, valuation procedure (rationale), sales evidence and calculations.
A valuation report is **legally relied upon** by lenders, mortage insurers and property owners. That’s why the valuer MUST ensure s/he follows mkt accepted valuation methodologies and reply upon current and relevant sales evidence. IF NOT e.g. potential negligence in forming their opinion of value, the party who relied upon the val report then suffered a financial loss as a result, then **may have recourse against the valuer.**
What does area usually mean in property valuation?
It usually means one of the these: gross building area (GBA), gross floor area (GFA), gross leasable area (GLA), and net lettable area (NLA). as we generally use income method in deriving prop value, most important defs of ‘area’ are these 2: gross leasable area (GLA) , and net lettable area (NLA).
Income stream or rent is obviously a main variable in determining prop val by income method. but to bring props to a common denominator, what adjustment needs to be made to income?
rental of comparable sales evidence is all reduced to a **net basis** (annual)
What gives rise to reversion calculations in forming prop valuation?
diff b/w mkt rent (what tenants agree to when the prop is still vacant) and actual rent (what tenants currently pay under lease agreement) gives rise to reversion calculations in forming prop valuation.
what are outgoings and recoveries? Gives some examples of normal outgoings.
- Outgoings are costs that must be property-specific and DO NO INCLUDE mortgage interest, income tax, depre etc. as those are prop investment-specific
- Examples of normal outgoings: water rates, sewerage rates, land tax, building and liability insurances, repairs and maintenance, lights, power and fuel for non-tenant areas, security, wages/salaries of personnel involved in maintaining and managing the property, management commission, historical vacancies, sundry expenses like cleaning of public areas, cleaning materials, removal of wastes etc., mkting, promotions …
- can vary significantly over time; responding to commercial and political pressures, outgoings can increase at a rate higher than inflation.
- adjustments to the outgoings and lease area rent can occur at **different times and rates.
- Recoveries - as (depending on the type of lease agreed) tenants may pay a portion of outgoings, some outgoings are **recoverable outgoings** and some are **non recoverable outgoings** . either way, it’s in proportion to tenant’s lease area, and actual liability and payment is undertaken by the landlord regardless if ended up fully recovering the costs paid
* if recoverable outgoings **- net lease** i.e. rental cost for the area occupied + an obligation to pay a negotiated level of outgoings.
* if non recoverable outgoings - **gross lease** tenants just pay one single gross rent amount and doesn’t contribute further re: outgoings.
What is passing rent?
It’s another term for actual rent (as opposed to market rent). Passing rent is either greater than or less than market rent. and that’s where reversionary adjustment comes in handy when valuating prop
* if prop is underlet - means contract rent you get < mkt level; overlet - contract rent > mkt level
* **when calculating current mkt value of the prop, you’d start with the val based on open mkt rent, less reversionary interest aka residual reversionary rental or rent reversion (i.e. PV of the loss of income b/w val date and date of next review). interest and term inputs must be on the same periodical basis (annual, monthly etc.)**
give a brief definition of capitalisation rate
the **crystallisation** of all current and future expectations and benefits that can be derived from the property, based on the **expectation that the current income will continue into perpetuity** and the prop will be worth a multiple of that income. (hence all props capable of earning rent can be valued by capitalisation)
* **anticipation** and **substitution**(prop or non-prop, what price was paid for alternative inv? ) are two important principles involved in the capitalisation process.
* selection of the cap rate will have a major impact on the val. (even a small change in the yld will have a major effect on the val determined, think about the formula MV = NI/yld)
How do you select the right cap rate?
you determine it based on mkt evidence i.e. analysis of sales/we can say cap rate is sourced from sales evidence of similar props and adjusted with regard to factors that affect the subject prop in the below bullet point** and then the analysed cap rate MUST be brought to common denomintor to that of the subject i.e. if gross rent from sales evidence, work out the net rent, then cap rate then apply it to the net rent of the prop being valued.
Define initial yield. What formula is used for calculating it?
Initial yield is expressed in terms of income derived from the prop at PURCHASE or at a given point in time) we are calculating then (it’s technically the same formula except the context is diff.
What is the formula for calculating reversionary yield? When does reversionary yield apply?
Reversionary yield applies if rents were at full market level.
Why does actual rent almost always differ from market rent?
It’s because contract usually includes a clause to conduct rental review every 1/2/3 years as per CPI, which results in rentals below/above the mkt level . Hence why valuer must decide whether there should be an adj. to equate the yld.
Discuss Cap Rate vs Discount Rate?
important to note that CR is NOT DISCOUNT RATE (as disc rate is used in the DCF val model which suits props that produce variable income stream, whereas capitalisation rate assumes a constant income stream into perpetuity
Explain what weighted average lease term is?
tenants are moving towards shorter lease terms and a greater number of options to ensure flexibility -> which gives rise to the use of **weighted average lease term** (weighted by the area occupied under each lease and not amount of rent, so as not to skew the average due to prop being over or under-rented
How is market rent determined?
have to analyse not just the tenancy schedule but also the mkt and the prop itself (nature of the prop, its use, location etc.)to determine **mkt rent** (recall that in prop val, we start with val at mkt level then work out reversionary interest to derive prop al as of today)
