Valuation Flashcards
What does the front cover of the Red Book look like?
- Global - prominent grey and red RICS written on it - RICS Valuation Global Standards, effective from 31st January 2022 - 296 pages
- UK supplement - white background, effective from 14th January 2019, issues November 2018 - 148 pages
Which sections of the Red Book are mandatory?
- Professional Standards:
- PS1 - Compliance with standards (example IPMS or Ethics) where a written valuation is provided
- PS2 - Ethics, competency (qualifying professional to undertake work)
- Valuation Performance Standards:
- VPS 1 - Terms of Engagement
- VPS 2 - Inspection, investigation and records
- VPS 3 - Valuation reports
- VPS 4 - Bases of value, assumptions and special assumptions
- VPS 5 - Valuation approaches and methods
What are the contents of the Red Book?
- 2 Professional Standards (PS’s)
- 5 Valuation Performance Standards (VPS’s)
- 10 Valuation Practice Guidance Applications (VPGA’s)
- Part 6 - Internal Valuation Standards (IVS)
Give me some examples of the VPGA’s, there are 10
- Valuation for inclusion in Financial Statements
- Valuation of interests for Secured Lending
- Valuation of businesses and business interests
- Valuation of individual trade related properties
- Valuation of plant and equipment
- Valuation of intangible assets
- Valuation of personal property, including arts and antiques
- Valuation of real property interests
- Identification of portfolios, collections and groups of properties
- Matters that may give rise to material valuation uncertainty
What is the UK supplement of the Red Book?
- Specific adoption for use in the UK where the Global Edition falls short
Can you give me some examples of guidance in the UK supplement of the Red Book that is different to the Global Edition?
- There are 15 UK Valuation Practice Guidance Applications (VPGA’s) including:
- Valuation of Local Authority Assets for account purposes
- Valuation of Charity Assets
- Valuation for Residential Mortgage purposes
- Valuation for Capital Gains, Inheritance, Stamp Duty and Enveloped Dwellings Tax
How does the Red Book define Market Rent?
- Estimated value of an asset which is to be leased on the valuation date
- Between a willing lessor and a willing lessee on appropriate lease terms
- In an arms length transaction after proper marketing
- Where both parties have acting knowledgeably, prudently and without compulsion
How does the Red Book define Market Value?
- The estimated amount for which an asset or liability should exchange on the valuation date
- Between a willing buyer and willing seller
- In an arms length transaction after proper marketing
- Where both parties have acted knowledgeably, prudently and without compulsion
How does the Red Book define Fair Value?
- Broadly similar to market value
- The price which would be received for an asset, or paid to transfer a liability in an orderly transaction
- Between market participants at the measurement date
- The definition is from IFRS 13
Tell me the 5 methods of valuation
- Comparative
- Residual
- Profits
- Investment
- DRC
Tell me how you would undertake a profits valuation
- Used for valuation of trade related properties such as pubs, bars, nightclubs
- Assess the fair maintainable turnover (FMT) through 3 years worth of accounts by a reasonably efficient operator (REO)
- Make an assessment of the gross profit from the FMT
- Assess the Fair Maintainable Operating Profit with allowances made based on the REO
- Assess the market value of the property (using comparative method)
- Capitalise the FMOP at an appropriate yield to reflecting the risk and return of the operator
- Allowances to be made for a new operator who would make improvements to the business
Tell me how you would undertake a residual valuation
A residual valuation is based on the concept that the value of a property with development potential is derived from the value of the property after the development, minus the costs of undertaking said development
- Gross development value - Gross development cost = residual land value
- It is a form of development appraisal to understand the development potential of a building and/or assess the price to be paid for the land
- DCF’s can be used for phased developments
- Inputs of a GDV:
- Valuation of the properties based on the clients requirements using comparable method with a market approach (do they wish to sell or lease) - taken at the valuation date
- For freeholds, comparable yields used to understand market value
- An allowance for tenants incentives as required
- Inputs of GDC:
- Site preparation e.g. clearance, remediation, landfill tax, contamination etc
- Planning costs e.g. S106, community infrastructure levy, affordable housing for LPA’s, planning consultant, environmental impact assessment
- Building costs e.g. Q.S bill of quantities, BS estimate, BCIS cost, contractor quotes
- Professional fees e.g. architects, consultants, CDM cost
- Contingency
- Finance for scheme (holding charges, interest )
- Developers profit (15-20% of GDV)
- Sensitivity analysis also required:
- Simple sensitivity in key areas such as fees, GDV estimates and finance rate
- Scenario analysis such as changing timings, content, modifying design
- Software can also be used for sensitivity analysis
Can you tell me what a yield is?
- A measure of investment return, reflecting a percentage of capital invested compared to market rent
- Yields also reflect relevant risk associated with an asset including:
- Prospects for rental and capital growth
- Quality of the location and covenant
- Use of the property and future use
- Lease terms
- Obsolescence
- Risk of voids
- Security and regularity of income
- Liquidity - ease of sale
Can you tell me different types of yields?
- All risks yield - based on a fully let property, let at a market rent, reflecting all the prospects and risks attached to the investment
- Gross yield - the yield adopted not adjusted for purchasers cost e.g. auction result
- Net yield - the resulting yield minus purchasers costs
- Running yield - the yield at one moment in time
- Initial yield - simple income yield for initial income
- Reversionary yield - a yield for a property below market rent, market rent divided by current price on an investment
Why do yields differ based on asset type?
- Expresses investment return and the prospects for rental and capital growth
- An assessment of risk and security of income have key factors:
- Location and covenant
- Use of the property
- Lease terms
- Obsolescence of the property
- Risk of voids
- Security and regularity of income
- Ease of sale
If you had an investor of X, what would you advise they invest in and why?
- Compare yield rates for different asset classes
- Look at the capital they wish to invest and the type of covenant which can be attracted based on the asset
- High Street retail is a falling market with yields between 6-8% with retail warehouses around 6-7% reflecting a better prospect of return
- Look at current trends - currently a lot of service based operators which pushes up demand for warehouse space
What are the terms of engagement for a valuation?
- Contained in VPS 1:
- Status of valuer
- Client
- Other intended users
- Asset or liability being valued
- Currency
- Purpose of the valuation
- Basis of value adopted
- Valuation date
- Nature of the work including investigation and any limitations
- Nature and source of information relied upon
- All assumptions and special assumptions
- Format of the report
- Restrictions on use and distribution of the report
- Confirmation the valuation will comply with IVS
- The basis of the fee
- The firm, including complaints handling procedure and a copy available upon request
- A statement regarding monitoring by the RICS
- A statement of any limitation of liability agreed
Tell me what statutory due diligence you would need to consider for a valuation?
- Asbestos register
- Business rates
- Any contamination
- Equality Act compliance such as disabled access
- Environmental matters
- EPC rating
- Fire safety compliance
- Highways
- Legal title and tenure
- Public rights of way
- Planning history
What personal checks do you need to carry out before commencing a valuation?
- A competency check
- Any conflicts of interest with the instructing party
- Check the terms of engagement - set out in writing your confirmation to carry out the work based on the terms in VPS 1 of the Red Book
Tell me how you would carry out a comparative valuation
- Competence check
- Check Terms of Engagement, Conflicts of Interest, PII
- Understand what type of valuation it is - market rent, capital valuation
- Conduct lease analysis if applicable
- Take measurements and areas for the property you’re valuing
- Search and select relevant comparable evidence, judgement using the hierarchy of evidence. Analyse comps based on proximity to property, use, pitch, how recent it is etc
- Verify details from counterpart by confirming with occupier or checking the lease
- Report an opinion of market rent to client, issue invoice
- Capital valuation:
- Prepare ERV as above
- Capitalise at appropriate yield based on factors effecting the property
- Obtain yield details from sale information and market reports
What guidance is there for comparable evidence?
- RICS Guidance Note - Comparable evidence in Real Estate, 1st Edition, October 2019
- General principles are evidence needs to be:
- Comprehensive
- Similar and possibly identical
- Recent
- The results of an arms length transaction
- Verifiable with the occupier
- Consistent with the market - special purchaser is someone who will overpay for space due to special interest
- The results of underlying demand
- If there is limited evidence, expand the search and make allowances for market conditions
- Real Estate markets are not fully transparent so treat information with caution e.g. unrepresented tenants
Tell me how you would carry out an investment valuation.
- It is used when there is an income stream to value
- Check competence, conflicts of interest, PII
- Issue terms of engagement
- The rental income is capitalised to produce a capital value
- The valuation assumes there is implicit growth (market conditions dictate possibility of growth and are reflected in the yield)
-
Conventional method:
- Rent received (market rent) multiplied by the years purchase = market rent
- Evidence key to determining ERV & yield
- Other methods include term & reversion (under rented) and hardcore & layer (over rented)
-
Term & reversion:
- Used for reversionary investments such as when the property is under rented
- The current term is capitalised until the event at an initial yield
- Reversion, depending on the market rent is capitalised at a reversionary yield (yield at reversion to perpetuity)
- Usually the reversionary yield would be higher than initial due the risk of change in market conditions
-
Hardcore & Layer:
- Used for over rented investments
- Bottom slice is market rent
- Top slice is passing rent until next lease event
- Higher yield applied to top slice to reflect the additional risk
- Different yield used depending on comparable evidence and the relevant risk
Can you tell me how you would carry out a DRC/Contracts valuation.
- Depreciated replacement cost used where there is no direct market evidence for specialist properties
- Examples such as schools, hospitals, museums, military bases
- Used for owner occupied properties for accounting purposes
- Inappropriate for Red Book valuation for secured lending
- Methodology:
- Value the land in its existing use
- Calculate the cost to replace the building (using BCIS) plus fees less a discount for depreciation and obsolescence
- Different types of obsolescence:
- Physical - wear and tear
- Functional - the design or spec of the building no longer fulfils the current function
- Economic obsolescence - changing market conditions for the use of the asset
What are the six steps used when collecting comparable evidence?
- Search and select comparable’s (agents board, online databases, tenant details)
- Confirm/verify information with a party directly involved in the transaction
- Assemble comparables in a schedule
- Interpret the evidence using the hierarchy of evidence
- Analyse comparables to form an opinion of value such as rent free analysis
- Report value and prepare file note