Red Book Valuations Flashcards
What are the 3 approaches of Valuation
- Income Approach
- Cost Approach
- Market Approach
What are the 5 methods of Valuation
- Investment
- Profits
- DRC
- Residual
- Comparable
Describe the Investment method
Utilised when their is an income stream to value.
The rental income is capitalised to produce a capital value.
Conventionally assumes growth implicit valuation approach - implied growth rate is derived from the yield
Describe term and reversion
Used for reversionary assets (under-rented)
Term capitalised to next lease event.
Reversion to market rent valued in perpetuity at a reversionary yield.
Describe Hardcore Layer
Used for over rented assets.
Income flow is divided horizontally
Bottom slice is market rent
Top slice is passing rent minus market rent until next lease event
Higher yield applied to top slice to represent increased risk
Describe Discounted Cash Flow (DCF)
Growth explicit investment valuation technique
Involves projecting estimated cash flows over an assumed investment holding period, plus an exit value at the end of the period, usually uses a ARY.
What is the methodology of a Discounted Cash Flow (DCF)
- estimate cash flow (income less expenditure)
- estimate the exit value
- select the discount rate
- discount cash flow at discount rate
- value is the sum of the completed discounted cash flow to produce the NPV
Describe the Profits method
Used for valuation of trade related property. Where the value of the property depends on the profitability of its business.
Involves establishing fair maintainable operating profit
What is the methodology for the Profits method
Annual turnover
less
costs and puchases
less
reasonable working expenses
to give the EBITDA
Capitalise at an appropriate yield to achieve market value
Describe the Residual Method of Valuation
Used for property with development potential. The output is the Market Value of land and it requires a variety of assumptions about input costs.
Describe the methodology of the Residual method
Gross Development Value (GDV)
Valued at current date assuming present values and market conditions
Comparable method to obtain rent and ARY
An allowance of rent free periods, tenant incentives and marketing void can be assumed
Purchasers costs deducted
Describe the Depreciated Replacement Cost (DRC) method of valuation
Used as a method of last resort, when there are no comparables.
Not suitable for Red Book valuations for secured lending
What is the methodology for DRC
- value in land in its existing use (assume planning permission exists)
- add current cost of replacing building plus fees less a discount for depreciation/obsolescence
What is the structure of the Red Book
- Introduction
- Glossary
- Professional Standards (PS)
- Valuation technical and Performance Standards (VPS)
- Valuation Applications (VPGA)
- International Valuation Standards (IVS)
What are the key changes from the previous Red Book
Valuation for financial reporting (VPGA 1) - References to IFRS 13 and 16 and the need to provide reasonable fair value measurements.
Sustainability and ESG - Glossary Interpretations of Sustainability and ESG provided -
Inspection VPS 2 / Reporting VPS 3 should have regard to sustainability factors which should form an integral part of the valuation approach and reasoning -
VPGA 2 sustainability should form an integral part of the valuation approach, commentary should be made about the maintainability of the future income stream
What is Professional Standard 1 (PS 1)
Compliance with standards and practice statements. Mandatory for all valuations except one of the 5:
1. Advice is expressly provided for negotiation or litigation
2. Statutory function
3. Purely for internal purposes, not communicated to a third party
4. As a part of agency work in anticipations of receiving instructions to dispose of or acquire an asset
5. Provided in anticipation of giving advice as an expert witness
What is Professional Standard 2 (PS 2)
Ethics, competency, objectivity and disclosures
Must act in line with RICS Rules of Conduct
Conflicts of Interest
Terms of Engagement
What is VPS 1
Terms of Engagement
What is VPS 2
Inspection, investigations and records
What is VPS 3
Reporting standards
What is VPS 4
Basis of value, assumptions and special assumptions
What is VPS 5
Valuation approaches and methods
What is a special assumption
A supposition that is taken to be true and accepted as fact, even though it is not true
What is an assumption
Made where it is reasonable for the valuer to accept that something is true without the need for specific investigation
What is a restricted information valuation
When a valuer is instructed to value on the basis of restricted information or without physical inspection.
Must consider:
1. The nature of the restriction must be in writing in the Terms of Engagement
2. Possible implications of the restrictions confirmed in writing before undertaking the valuation
3. Should consider if the restriction is reasonable with regard to the purpose of valuation
4. Restriction must be referred to in the report
Define Fair Value
The price that would be received to sell an asset in an orderly transaction between market participants at the measurement date
Define Market Value
The estimated amount for which an asset should exchange on the valuation date between a willing buyer and willing seller in an arms length transaction.
Define Market Rent
the estimated amount for which an interest in real property should be leased at on the valuation date between a willing lessor and willing lessee in an arms length transaction.
Define Investment Value
The value of an asset to a particular owner or prospective owner for individual investment or operational objectives.
What is VPGA 1
Valuation for inclusion in financial accounts. Should be valued to Fair Value
What is VPGA 2
Valuation for secured lending purposes.
COI for secured lending:
Any previous, current or anticipated involvement with the prospective borrower or property
Reporting procedures:
1. Valuation methodology adopted and calculations
2. Comment on environmental consideration
3. Suitability for the loan for mortgage purposes
4. Any circumstances that the valuer is aware of that could affect the price
What is VPGA 10
Material uncertainty
A valuation report must not be misleading
Should draw attention to any issues resulting in material uncertainty on the specified valuation date relating to the risk of the valuation of the asset
A standard caveat should not be used
What is UK VPS 3
Valuation monitoring
Valuations relied on by third parties who have not commissioned the valuation and they are subject to valuation monitoring.
Valuations for 5 purposes:
1. Financial reporting
2. Unregulated property unit trusts
Secured lending are not regulated purpose valuations as they’re not relied on by third parties
What are valuation monitoring requirements
An annual declaration to declare the length of time a valuer has acted for the client for regulated valuation purpose and the extent and duration of the firms relationship with the requirement.
There should be a rotation of valuers when the asset is regularly valued. The RICS recommends 7 years.
What were the outcomes of the Independent review of investment Valuations by Peter Gray?
Have been accepted in full and will be implemented in due course.
1. Developing a valuation compliance officer at firms
2. Process to raise concerns about ethical conduct, including improper pressure placed on valuers
3. DCF as the principal method of investment valuations
4. Continue to work on diversity and inclusion
What is the name of the RICS ESG Guidance for commercial valuation
Sustainability and ESG in commercial property valuation and strategic advice (2021)
What is ‘Sustainability and ESG in commercial property valuation and strategic advice’ (2021)
Guidance note - mandatory
Releveant sustainability considerations, characteristics and risks which should be in mind when analysing comparable evidence
how these should be reflected in valuation methodology
How do you identify if a road is adopted?
Confirm on the local councils website?
What are the business rates relief for each asset class?
Retail - 3 months
Office - 3 months
Industrial - 6 months
How do you calculate a yield?
Income divided by the price times 100
How do you calculate YP?
100 divided by the yield
What are the enhanced conflicts checks for a secured lending valuation?
Any previous, current or anticipated involvement with the prospective borrower or property must be disclosed to the lender.
Previous involvement is defined as 2 years but can be longer.
A conflict may arise when:
1. there is a longstanding relationship with prospective borrower
2. when the valuer is retained to act in the disposal or letting of the completed development
Why is the red book used?
It provides clear instruction for a valuation that is regulated by the RICS. It helps to ensure that valuations are conducted to a high standard and helps to promote trust in the profession
Example of an assumption
Property complies with planning regulations
A tenant will not exercise the break or they will exercise the break
Example of a Special assumption
Vacant possession
Anticipating a new letting
What does VPS 2 say about records?
Proper records must be held of the inspections and investigations and other key inputs.
Notes the importance of sustainability
What is a DCF?
A growth explicit investment valuation
Methodology of a DCF?
Estimate cash flow
Estimate exit value
Select the discount rate
Discount cash flow at the discount rate
Value is the sum of the completed discounted cash flow to provide the net present value (NPV)
What is the NPV?
The sum of the discounted cash flow, it can be used to determine if an investment gives a positive rate of return against the target rate.
Positive = exceeded target
Negative = not achieved investors target rate of return
What is the Internal Rate of Return (IRR)
The rate of return at which all cash flows must be discounted to produce an NPV of 0. It is used to assess the total rate of return from an investment.
What is included in a red book terms of engagement?
- Name and address of the property
- Name of client
- Valuation date
- Conformation of the valuer and that they are competent
- Purpose of valuation
- Basis of value
- PII Cover
- Conformation of red book compliance
- Format of the report
- Assumptions / special assumptions
- Fee
- Details of where to fine the complaints handling procedure
Why would you adopt a SWOT analysis?
I would adopt a SWOT analysis because it is a useful tool to analyse the internal and external factors that might affect the property
What is Fair value?
The price that would be received to sell an asset in an orderly transaction between market participants at the measurement date
Required if IFRS has been adopted
What is Investment value?
The value of an asset to a particular owner or prospective owner for an individual investment.
Used as a measure of worth to reflect the value against the clients own investment criteria.
Can you provide an example of a special assumption?
Market Value with vacant possession
Can you provide an example of an assumption?
Why is zoning important?
Zoning is important because the shop front is the most valuable area of the store and as such the mast value should be attributed to this area.
It is an important tool when comparing retail properties to ensure that the value is attributed to the shop front.
What is the purpose of zoning?
To attribute the most value to the most valuable area of the shop.
To help compare like for like
What are standard due diligence checks?
Planning
Ratable value
Flood risk
Contamination
Legal title
Highways
Environmental matters (masts, power lines etc)
What is VPGA 1?
This is the valuation application for valuations for inclusion in financial accounts. Confirms that Fair Value will be used for IFRS
What is VPGA 2?
This is the valuation application for valuations for secured lending.
It lays out the reporting procedures for secured lending valuations including;
Comment on environmental consideration
Comment of the suitability for the loan
How would you do a term and reversion?
Used for reversionary investments.
Term capitalised until next lease event at an initial yield
Reversion to market rent valued in perpetuity at a reversionary yield
How would you do a hardcore layer?
Used for over rented investments
Income flow divided horizontally
Bottom slice = market rent
Top slice = rent passing less market rent to next lease event
Higher yield to top slice to reflect additional risk
Yields dependent on comparable evidence and relevant risk
What is your opinion on DCF?
What was recommended by Peter Gray in the independent review of investment valuations (Dec 2021)?
- Rotation process for valuers
- A valuation compliance officer within firms
- Processes to raise concerns about ethical
conduct, including improper pressure on
valuers - DCF as the principle model
- Review of post-qualification requirements
for valuers
What is an equivalent yield?
Average weighted yield when a reversionary property is valued using an inital and reversionary yield
What is an all risks yield?
Used in the valuation of fully let properties let at market rent reflecting all the risks and prospects attached to the particular investment
What is an inital yield?
Simple income yield for current income and current price
What is a reversionary yield?
MR divided by current price on an investment let at a rent below MR
Talk me through the methodology of a comparable valuation
- Search and select comparables
- Confirm details and analyse headline rent
to give net effective rent - Assemble comparables in schedule
- Adjust comparables using hierarchy of
evidence - Analyse comparables to form opinion of
value - Report value and prepare file note
What is VPS 1?
Terms of Engagement
What are the drawbacks of KEL?
The results are only accurate if the correct data is inputted.
What are the positives of KEL?
It is an easy to use system that allows a valuer to input all the necessary lease information and opinions of value.
Helpful to add the valuation print out at the back of a report.
Gives a running yield report
What are the exemptions to using the Red Book?
- Advice is provided during the course of
negotiation or litigation - A statutory return to a tax authority
- Purely for internal purposes, without
liability or third party reliance - Agency work in anticipation of instruction
- For evidence as an expert witness
What are the three steps before completing a valuation?
Competence
Independence
Terms of Engagement
What is the loan to value ratio for commercial properties?
60%
