Valuation Flashcards
Explain Special Purchaser
Where a particular asset has special value to a particular purchaser because of advantages arising from its ownership that would not be available to other buyers in a market.
What is an IRR?
a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero.
What is the Red Book
Set of global standards which set out procedural rules and guidance for written valuations.
what is the full title of the latest red book?
RICS Valuation – Global Standards 2022
31 January
Purpose of the red book
Greater consistency, objectivity and transparency
why has the red book been updated?
- Because the IVS (international Valuation standards) are updated on a rolling program every 2 years new IVS 2022.
- Red book needed minor updates to stay aligned with IVS 2022
- To increase focus on sustainability and ESG.
What does ESG stand for?
Environmental, social and governance
who creates the International valuation standards?
Valuation professional organisations such as RICS and the American Society of Appraisers.
Professional standard 1 in the red book is about?
Compliance
Professional standard 2 in the red book is about?
Ethics and conflicts
are there any exceptions where the valuer may not follow the VPS’s? (5)
Agency marketing appraisal Litigation (rent review litigation) Internal purposes only Expert witness valuation Statutory basis
ALIES
Professional Standard 1 changes
- It must be clear and unambiguous within the terms of engagement if members are to apply any exceptions to VPS 1-5 under PS 1.
- Red book compliance is binary. Valuation is either a Red Book valuation or it is not. No more partial red book.
what are the terms of engagement?
Contract with the client detailing the work assignment, can be used as an important defence against negligence claims.
what is market value?
Estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.
what is market rent?
Estimated amount for which an interest in real property should be leased on the valuation date between a willing lessor and a willing lessee on appropriate lease terms in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.
define investment value
Value of an asset to the owner or prospective owner who has investment objectives.
Often used in conjunction with DCF.
What is fair value?
- IFRS 13 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
- Applies only to financial statements.
what do understand about synergistic value
- Defined in VPS 4
- Synergistic value is the result of a combination of 2 or more assets where the combined value is more than the sum of the separate values.
what are the three valuation approaches described in VPS 5?
M - Market
I - Income
C – Cost
MIC
what is the market approach as per VPS 5
Based on comparing the subject asset with identical or similar assets or liabilities, where price information is available, and you can compare similar market transactions within an appropriate time period.
I.e. The comparable method
what does VPS 1 relate to?
Terms of engagement
what does VPS 2 relate to?
Inspections, investigations and records
what does VPS 3 relate to?
Valuation reporting and methods
what does VPS 4 relate to?
Basis of valuation
what does VPS 5 relate to?
Valuation approach
name at least 10 headings you would expect to find in a terms of engagement
- Identification and status of valuer
- Identification of client
- Identification of any other intended uses
- Identification of asset or liability being valued
- Valuation currency
- Purpose of the valuation
- Basis of value adopted
- Valuation date
- Nature and extent of the valuer’s work, investigations and limitations
- Nature and source of information which the valuer will rely
- All assumptions and special assumptions to be made
- Format of report
- Restrictions on use, distribution and publication of report
- Confirmation that the valuation will be undertaken in accordance with the IVS.
- Basis on which the fee will be calculated.
- For RICS regulated firms, reference to complaints handling procedure
- A statement that compliance with these standards may be subject to monitoring under RICS conduct and disciplinary regs
- Statement setting out agreed limitations
name at least 10 headings you would expect to find in a red book valuation report
- Identification and status of valuer
- Identification of client and other intended uses
- Purpose of valuation
- Identification of asset or liability to be valued
- Basis of value adopted
- Valuation date
- Extent of investigation
- Nature and source of information relied upon
- Assumptions and special assumptions
- Restrictions on use, distribution and publication of report
- Confirmation the assignment is in accordance with the IVS
- Valuation approach and reasoning
- Valuation amount
- Date of valuation report
- Commentary on any material uncertainty in relation to the valuation
- Statement setting out any agreed limitations on liability
what is the income approach based on?
Capitalisation or conversion of present and future incomes to a single capital value
Two methods: 1.) capitilaisation of a conventional market based income. 2.) discounting a income projections
Deciding by consideration of what is standard in the market.
E.g. investment and profits method
What is the cost approach based on?
Gives an indication of value using the economic principle that a buyer would pay no more for an asset than the cost to get an equal asset by construction or purchase. E.G. Residual method and Depreciated replacement cost method.
what is the document “RICS Sustainability and ESG in commercial property valuation and strategic advice?
Global guidance note released in 2021
Covers definitions of ESG, role of sustainability and the role of the valuer
Explores sustainability characteristics, considerations and risk
have any valuation reviews been conducted recently?
Yes Peter Gray’s independent review of real estate investment valuations in December 2021.
Can you name two recommendations commissioned by RICS, standards and regulation board following Gray’s independent review of real estate investments?
- Creation of an independently led panel to assist in RICS regs in valuation
- Creation of a formal valuation compliance officer
- Identified the need for further guidance on RICS’ expectation of culture and expected behaviours of RICS professionals undertaking valuations.
I - Independent panel
C - Creation of compliance officer
E- Expectation of culture and behaviours
A.K.A ICE
Not including the red book are there any other RICS documents on valuation standards?
RICS valuation – global standards UK national supplement
- The UK national supplements the Global Red Book for valuations subject to UK jurisdiction.
- January 2019.
- New version coming 2022 to reflect recommendations from Gray’s 2021 Independent Review into Investment Valuations.
is the RICS valuation – global standards UK national supplement aligned with the 2022 red book
No it is based on the 2017 red book
Due for update autumn 2022.
Talk me through your valuation of the Garage in Shirley.
- Property – type, location
- Purpose of valuation – rating, asset
- Basis of Valuation – market value, market rent
- Terms of engagement – as per VPS 1
- Method used – comp, investment
- Technique – term and reversion, residual
- Advice to client – 2 to 3 points
Talk me through your valuation of the Land parcel in Aldridge and the advice provided
- Property – type, location
- Purpose of valuation – rating, asset
- Basis of Valuation – market value, market rent
- Terms of engagement – as per VPS 1
- Method used – comp, investment
- Technique – term and reversion, residual
- Advice to client – 2 to 3 points
Talk me through your valuation of the school in Derby and the advice provided
- Property – type, location
- Purpose of valuation – rating, asset
- Basis of Valuation – market value, market rent
- Terms of engagement – as per VPS 1
- Method used – comp, investment
- Technique – term and reversion, residual
- Advice to client – 2 to 3 points
How do you execute a valuation using the comparable method?
- Look at subject property (sale and letting evidence)
- Select comps (verify info)
- Analyse comps
- Display comps and subject in summary matrix
- Value property
- Stand back and look
LSA-DVS
Why do we make adjustments to comparables when valuing using the comparable method?
- To express the comparable in like terms to the subject.
- e.g. if the comparable has a poorer location the valuer attempts to estimate how much more the property would have sold for had it been in the same position as the subject property.
How do you analyse comparables?
Review price per area rate
Display key findings in a table
Research if the transaction is open market, transaction amount, size, location, date of transaction, specification, condition and layout
why did you do a residual appraisal for the garage in Shirley?
- Valuing market value
- Unconnected buyer (no special purchaser) would be aware of PP and want to negotiate a share of developers profit.*
- Agreed and set out in terms of engagement that market valuation will consider the fact that planning permission of the garage had been granted.
What was the valuation date for the garage in Shirley
Date of the notice to exercise the option to re-purchase the garage.
20th Feb 2020
did you provision affordable housing in your garage valuation?
No
The Affordable Housing contribution threshold for residential development sites is for residential sites of 11 units or more
What sales prices did you adopt for the houses in your garage appraisal?
£265,000 for 2BED end terrace house (2)
£300,000 for 3BED mid terrace house (1)
£305,000 for 3BED semi-detached (4)
What was the GDV of the garage appraisal
£2,050,000 (7 bed)
£1,440,000 (5 bed)
What costs did you deduct for the garage appraisal?
- Construction costs provided in council appraisal, I cross referenced with BCIS median quartile figures.
- Externals @ 15%
- Professional fees 9%
- 5 months sales period
- Finance costs @ 7% interest
- Agent fees 1% legals 0.5%
- CIL £52K
- Marketing costs 3% of MV of houses, legals at £600/house
- Developers profit @15% of GDV
Why is there only a £2,000 increase from existing use value and market value of the garage in Shirley?
- I Reviewed the case Stokes v Cambridge Corporation (1961) – 50% share if the land provides sole access – 1/3 share if alternative access
- I looked at the view of a willing buyer negotiating a 5% share of the increased profit which is £4,550
- I then applied a 50% share of this to reflect modifying the restrictions of the transfer document (which is possible through the Upper tribunal courts) (see law of property act 1925)
- Leaves £2,275 less some to reflect time and costs incurred, Say £2000.
Tell me about the profits method of valuation
- Used for valuing trade related properties in markets where there is a monopoly position
- Used where the value of the property depends on the profitability of the business and trading potential
- Used for pubs, petrol stations, hotels, day nurseries, leisure and healthcare properties.
- Basic principle is the value of the property depends on the profit generated from the business not the building or location.
- Need accurate accounts for 3 years if possible
tell me about the investment method of valuation
Used when there is an income stream to value.
4 techniques: term and reversion, hardcore and layer, hardcore and top slice and DCF
why didn’t you use the profits method to value the day nursery in Derby?
Council owned and ran so profitability is not a key aspect of the property or the business.
How is the market value calculated using the profits method?
Annual turnover Less Costs / purchases = Gross profit Less working expenses = unadjusted net profit Less owners remuneration = adjusted net profit / Fair Maintainable Operating Profit FMOP X Years purchase = Market Value FMOP = divisible balance
What is the term and revision technique and what are the steps to carry it out?
- An Investment method of valuation used for reversionary investments where the subject is under-rented.
- capitalise passing rent using YP at discounted yield for remaining years
- capitalise reversion using market rent into perp using YR at full market rate discounted using present value.
- Add together
- Stand back and look
what is the hardcore and layer technique and what are the 4 steps?
- Investment method of valuation used for properties valued for the institutional investment market
- Example being prime offices
- Capitalise term into perpetuity at equivalent yield
- Capitalise reversionary top slice at equivalent yield deferred until reversion
- Add together
- Stand back and look
what yield is used with the hardcore and layer valuation technique?
Equivalent yield
When is it useful to adopt the hardcore and layer valuation technique?
When the reversion is close in time.
Describe how a hardcore and layer valuation technique graph would look?
- Hardcore layer of passing rent along whole of x axis
- Horizontal reversion slice on top set that starts in the future (ahead of current time).
what is the hardcore and top slice technique?
Investment method of valuation used for investments where the subject is over-rented
Talk me through the steps of valuing a over rented shop from start to finish
- Establish market rent by comparable analysis
- Establish passing rent by reviewing the lease
- Establish market yield using comparables and risk analysis
- capitalise Market rent into perpetuity using market yield
- capitalise top slice (rental amount above market rent) until next review if rent can go down or lease end if not, using market yield uplifted to reflect risk.
- Add together hardcore and top slice.
- Stand back and look
In the hardcore and top slice technique what is the top slice?
The amount of rent above market rent
Describe how a hardcore and top slice valuation technique graph would look?
- Hardcore layer of market rent along whole of x axis
- Horizontal Top slice of amount of excess rent on top that starts from the onset
what yield would you commonly use for valuing a shop that is over rented?
Net initial Yield
what valuation technique might you use to value a shop that is under-rented?
Term and reversion
name five factors that can affect a yield
Risk Growth potential Quality of location Quality of covenant Property use Lease terms Voids Liquidity Obsolescence / Repair
Why would a surveyor complete a discounted cash flow?
- For a new property where growth is not yet stable
- New project where occupancy is not at peak levels
- To establish the internal rate of return
- To consider each rental growth separately
SORG
Stable. Occupancy. Return. Growth
What can a DCF look like, talk me through the different parts it will have.
- Time period on left hand side
- Net income (rent)
- YP @ cap rate (exit rate)
- Growth rate £1 @ say 2%
- Discount rate PV £1 @ 10%
- DCF total
- Remark/comment section at end
Talk me through the steps of valuing an over rented shop from start to finish
-Establish market rent by comparable analysis
-Establish passing rent by reviewing the lease
- Establish market yield using comparables and risk analysis
-capitalise Market rent into perpetuity -using market yield
capitalise top slice (rental amount above market rent) until next review if rent can go down or lease end if not, using market yield uplifted to reflect risk.
-Add together hardcore and top slice.
-Stand back and look
How would you carry out a DRC?
- Establish replacement cost of modern equivalent property
- Depreciate for age and obsolescence (functional, technical + economic)
- Add land value
- = Capital Value (up to here for school example)
- Depreciate at statutory decap rate for rating valuations (4.4% or 2.6% for health)
- = Annual Rental Value
how would you carry out an investment method of valuation?
- Establish if property is over or under rented
- If it is under rented complete a term and reversion
- Capitalise passing rent using YP at discounted yield to end of term
- Capitalise market rent into perpetuity using yp at market ratee
- Add together
- Stand back and look
CCAS
What is YP?
Years purchase is the number of years it would take for the annual income to pay for the value or purchase price of the property.
what about if a shop you was valuing was over-rented? How would you value?
- Capitalise passing rent at higher rate using YP to term end
- Capitalise market rent at market yield - YP into perpetuity
- Add together
- Stand back and look
CCAS
What does VPGA stand for?
Valuation practice global applications
Are you aware of any VPGA’s
VPGA 1 – Financial account valuations VPGA 2 – Valuations for loan security VPGA 3 Valuation of whole businesses VPGA 4 Profits valuations VPGA Real estate valuation (inspection) VPGA 10 Material uncertainty
can you run me through how you would do a profits valuation
- Obtain 3 years accounts showing income, purchases, expenses
- Determine fair maintainable turnover (for a reasonable occupier)
- Deduct costs and expenses to calculate Fair maintainable operating profit FMOP
- CAPITAL VALUE = FMOP X YP
- RENTAL VALUE = FMOP = Divisible balance (50/50 Landlord and tenant)
why would you multiply the operating profit by the years purchase to calculate capital value?
- You have the yearly profit
- The YP is the number of years profit it takes to attain the level of value of the property.
- So multiplying the two gives you the overall value.
what are the principles behind the divisible balance
represents the amount to be shared between the tenant (tenant’s share) and the landlord (rent, or rateable value).
What is fair value
Amount which would be paid for an asset or to transfer a liability in an orderly transaction between market participants at the measurement date.
What is marriage value?
the increase in the value of the property following the completion of the lease extension, reflecting the additional market value of the longer lease.
Difference between old value and new value is split 50:50 between landlord and leaseholder
What is functional obsolescence?
Looks at property decrease in functionality due to outdated design features pr physical deterioration
What is technical obsolescence?
Where the building is inferior to alternative
What is economic obsolescence?
depreciation in the market value of a property due to external factors that cannot be controlled by the owner.
Examples include: traffic pattern changes, zoning changes, flight pattern changes, construction of public nuisance projects like a jail or sewer treatment plant, rising crime, or job loss.
why did you look to negotiate a 5% share for the garage in Shirley?
Stokes v Cambridge
Sourced from Lexis Nexis case law demonstrates that percentages between 5–50% have been settled.
This depends on the facts of the individual cases and the bargaining strengths of the parties in question.
The ability of a development to proceed without the inclusion of the subject garage property weakens the bargaining strength of the unconnected willing buyer a percentage share towards the lower end of the 5%-50% scale would be realistic.
how did you know a scheme of 5 units could be developed in Shirley?
It was the last garage left
Its location would have prevented development of a block of two semi-detached 3 bed houses
I still believed a scheme of 5 units could be built around the garage.
For the garage what was the value differences between using the residual method and comparable?
Minimal.
Comparable valued @ £400k for 7 bed scheme compared to £430,000 for residual
what advice did you provide on values reflecting development potential for garage?
Value of development site £400,000 comparable method Value of land 7 bed scheme - £430,000 Value of land 5 bed scheme - £305,000 7 bed scheme profit – £307,000 5 bed scheme profit - £216,000
what advice did you provide on share of the developers profit for the garage valuation
I advised that a 5% share of the difference between the two developers profits could be negotiated by a unconnected willing buyer.
What is professional scepticism?
Having a questionable mindset in regard to information and evidence.
PS 2
Who signs off Red book report?
An individual (chartered surveyor)
not a firm.
Who is to be named in a Red book report?
Anyone with a material supporting role in the valuation
Do you follow VPGA 15 – valuations for CGT, IHT, SDLT and ATED
Mainly aimed at private agents dealing client side
But we do follow
name the guidance note for comparative valuation methodology
Comparable evidence in Real Estate Valuation (1st edition) 2019
What different yields are you aware of? Name and describe at least 3
All risks yield - reflects all risks, returns and growth
Initial yield - ARY applied to passing rent
Gross initial yield - yield on investment before deducting expenses
Net initial yield - yield on investment after deducting annual expenses. Expressed as a percentage of capital value plus purchaser costs (used in hardcore and top slice)
Reversionary Yield - applied to the reversion (market rent) to reflect risk. Yield that should be achieved if passing rent adjusts to market rent
Equivalent yield - weighted average between term and reversion (used in hardcore and layer institutional market)
Equated yield - internal rate of return with explicit growth
what is a yield
Yield refers to the earnings generated and realised on an investment over a particular period of time and is expressed asa percentage based on the invested amount.
Income/price x 100 = yield
Basically what is the return for the investor after say 1 year
What is included within the global Red Book?
Professional standards (PS) 1 & 2 which are MANDATORY
Valuation technical and performance standards (VPS) 1-5 which are MANDATORY
Valuation Practice Guidance (VPGA’s) 1-10 ADVISORY
what is a discount rate?
Rate of interest selected when calculating the present value of a future cost or benefit.
what is all risks yield
Growth implicit yield used in an investment valuation that reflects all the risks and rewards of the subject property.
Name the consultative paper on investment valuation currently being considered by RICS?
Independent review of real estate Investment Valuation
Why is there a need for UK guidance as well of global standards (Red Book)?
Global Valuation Standard is to enable consistence and transparency globally, whilst UK guidance is specifically for the UK market, align with the UK jurisdiction and practice
- to incorporate VPGA’s on aspects specific to the UK such as Inheritance tax and CGT.
Why and when was the Global Covid-19 valuation practice alert withdrawn?
The Practice Alert was withdrawn March due to the fact that COVID 19 is now mature and most countries have lifted the restrictions, although Valuer will be required to decide if they want to continue to add the material uncertainty cluse within their report on a case by case basis.
What professional fees are considered in a residual valuation
Costs related to the hard construction costs of the scheme
May include environment/planning consultant, architect, QS, Civil engineer, Mechanical and electrical engineer and project managers.
Typically, these costs are estimated by valuers at 10–20% of the hard construction costs; however, they vary depending on the complexity of the development.
What is the difference between gross & net yield?
Gross yield is when the total rental income divided by the capital of the property without accounting for purchaser cost, whilst net yield will include purchaser cost such as SDLT and legal fees
Tell me about the special purchaser effect on the land in Aldridge
The owners of the adjoining dwelling house have expressed an interest in purchasing this property from the Government Legal Department. The also own the dwelling house on the other side of the property.
They are of the nature of a ‘Special Purchaser’. The property would have a special value to them as Special Purchasers which reflects the advantages arising from its ownership that would not be available to other buyers in the market.
ownership of the land would also remove the possibility of another unknown land owner acquiring the land between their two properties.
transfer of the freehold interest in the subject land would expand the size of their holding
It is considered difficult to place a value on the additional amount the Special purchaser would pay for the advantages arising from its ownership that would not be available to other buyers in a market so a value at the upper part of the range (£18,000 of a range 10k-22k) of the analysed comparable transactions have been considered and has been adopted to reflect the premium.
what is a discount rate?
Rate of interest selected when calculating the present value of a future cost or benefit.
Define what a Basis of value is
Set of assumptions that guide how a valuation is done
Define what a method of valuation
The techniques and approach that a valuer will carry out to value a property or land interest.
Most recent Red book when is it effective from?
31 January 2022
Do you undertake any environmental checks before valuing?
Yes Ground contamination Previous site use Asbestos Flood risk Overhead power lines Invasive species
If you were to value a multi-let office how would you approach that?
Investment method – establish MR and PR and calculate values using term and reversion or hardcore approaches.
Cross-check with comparable method
Would your valuation change if the interest was held leasehold as apposed to freehold?
Depends on the situation.
The price difference between a long leasehold vs freehold may not be substantial but the price difference between a short leasehold vs freehold property can be extremely significant.
The same property, in the same location, is likely to be more expensive if it is sold with a freehold title than if it is sold with a leasehold.
What is hope value and how would you reflect in a valuation?
An element of market value in excess of the existing use value, reflecting the prospect of some more valuable future use.
Could be reflected by an uplift in the £ per acre dependant on the likelihood of a new alternative use becoming more certain.
What is Estimated realisation price
Estimated Realisation Price”, (“ERP”) a basis of valuation to be used solely for loan valuation purposes.
ERP is identical to OMV in representing an exchange price in the market place, but it differs on a number of points, two of which are fundamental.
‘Reasonably expected’ is retained in the ERP definition but the two fundamental points are:
(i) the marketing period commences on the date of valuation, with the sale completed after a reasonable marketing period to be specified by the valuer.
(ii) the market is dynamic and is not assumed to be static over the marketing period.
Criticisms of estimated realisation price
Can be quite subjective. Being asked to forecast value at some point in the future.
When can you take account of hope value?
Can be included in OMV if it would have been known to someone in open market.
What does SORP stand for?
Statement of recommended practice
What does a RICS HomeBuyer Survey include?
Inspection
Concise report based on inspection
Valuation
How would you chose a discount rate for an IRR?
Adequate rate of return that compensates investor for risk taken
A discount rate (hurdle rate / equated yield) reflects the time value of money
Should reflect the relative risk of the project and the returns that could be made elsewhere
Use the required rate of return for the fund
What are the key methods to establish an effective rent?
Set total income and expenditure (including incentives) against equivalent lease that assumes no incentives to let had been granted (applying discount rate)
Set total income and expenditure (including incentives) against equivalent lease that assumes no incentives to let had been granted (ignore timing of cash flows)
DCF approach
How do you judge the viability of a project?
Payback - how long to repay initial outlay
NPV - given rate of return, does the project add value (NPV > 0 add value)
IRR - does project beat your target rate of return
