Valuation Flashcards
What are the five methods of Valuation
1) Comparative Method
2) Investment Method
3) Profits Method
4)Residual Method
5) Depreciated Replacement Cost)
IVS 105 Valuation Approaches and Method?
1) Income approach
2) Cost approach
3) Market approach
What is the Income approach? and what methods of valuation fall under it?
The income approach converts current and future cash flows into a capital value
Methods: Investment, Residual and Profits
What is the Cost approach? and what methods of valuation fall under it?
references to the cost of the asset whether by purchase or construction.
Methods: DRC Method
What is the Market approah? and what method of valuation fall under it?
Using comparable evidence available.
Methods: Comparable method
What are the 6 steps to the comparable method?
1) Search and select comparables
2) Confirm/verify details and analyse headline rent/etc
3) Assemble comps schedule
4)Adjust comparables using the hierarchy of evidence
5) Analyse comparables to form opinion of value
6) Report value and prepare file note
RICS Guidance note for Comparable Method
Comparable Evidence in Real Estate Valuation, 1st edition, 2019
What are the 3 hierarchy of Evidence Categories?
Category A - Direct comparables
Category B - General Market data that can provide guidance
Category C - Other Sources
How do you find relevant comparables?
Through inspection of local area and agents boards
Visit/Speak to local agents
Auction results (careful as could be a special purchaser)
In House records/databases and websites such as EGI and Focus
When would you use the Investment method?
When there is an income stream to value
What is the conventional investment method?
Rent received or Market rent multiplied by the years purchase = Market value
There is an importnace on comparables for rent & yield.
Term and Reversion method
Used for reversionary investments (where Market rent is more than Passing rent, i.e when the property is under rented.
The term is capitalised until the next review/lease expiry at an initial yield
The reversion to Market Rent valued in perpetuity at a reversionary yield
Layer/Hardcore method
Used for over rented investments (Passing rent is more than Market Rent).
Income flow divided horizontally
Bottom Slice = Market Rent
Top Slice = Rent Passing less market rent until next lease event
Higher yield applied to top slice to reflect additional risk
Different yields used depending on comparable investment evidence and relative risk
What is a yield?
A measure of investment return, expressed as a percentage of capital invested
How is a yield calculated?
A yield is calculated by income diveded by price x 100.
Why do we use different yield for different properties?
XXXXXXXX
Prime and Secondary Yields for X EACH MAJOR USE CLASS
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What is the Years purchase and how is it calculated?
This is the number of years required for its income to repay its purchase price.
It is calculated by dividing 100 by the yield
What is the most important factor in determining yield?
RISK
What factors does Risk relate to when determining yields?
Rental and capital growth
Quality of location
Covenant
Use of the property
Lease terms
Obsolescence
Voids
Security and regularity of income
Liquidity - ease of sale
What is a return?
Used to describe the properties performance. It measure retrospectively
It’s used in a DCF calculation to find the IRR
what differentiates prime and secondary yields?
There is a gap between prime and secondary yields to reflect the factors of risk.
Define All Risks Yield
the remunerative rate of interest used in the valuation of fully let property let at market rent reflecting all the prospects and risks attached to the particular investment
Define True Yield
Assumes rent is paid in advance, not in arrears
Nominal Yield
Initial yield assuming rent is paid in arrears
Gross Yield
Yield not adjusted for purchasers’ costs
Net yield
the resulting yield adjusted for purchasers costs
Equivalent yield
Average weighted yield when a reversionary property is valued using an initial and reversionary yield
Initial yield
Simple income yield for current income and current price
Reversionary yield
Market Rent (MR) divided by current price on an investment let at a rent below MR
Running Yield
The yield at one moment in time
What is a DCF
A Discounted Cash Flow is a growth explicit investment method of valuation.
It involves projecting estimated cash flows over an assumed investment holding period, plus an exit value at the end of that period, usually arrived at on a conventional ARY basis. The cash flow is then discounted back to the present day at a discount rate (also known as desired rate of return) that reflects the perceived level of risk.
- This approaches separates out and explicitly identifies growth assumptions rather than incorporating them within the ARY
when is a DCF used?
- short leasehold interests and properties with income voids or complex tenures
- Phased development projects
- Non-standard investments (such as 21 day rent reviews)
- Over-rented properties & Social Housing
RICS Guidance note on Discounted Cash Flows
Discounted Cash Flow for commercial property investments’, 2010.
Simple methodology to find market value using DCF
1) Estimate the cash flow (income less expenditure)
2) Estimate the exit value at the end of the holding period
3) Select the discount rate
4) Discount the cash flow at the discount rate
5) Value is the sum of the completed DCF to provide the NPV
What is the NPV and what does it show?
It is the sum of the discounted cash flows of the project
It can be used to determine if an investment gives a positive return against a target rate of return
If positive it has exceed investors target rate of return
If Negative, it has not achieved the investors target rate of return
What is the IRR?
Internal Rate of Return - the rate of return at which all future cash flows must be discounted to produce an NPV of 0.
What is the purpose of the Profits Method of valuation?
Used for vals of trade related property, where there is a ‘monopoly’ position.
Where the value of the property depends upon the profitability of its business and its trading potential.
Examples of types of property where the profits method would be used
Pubs
petrol stations
hotels
guest houses
childrens nurseries
leisure and healthcare properties
Care homes
Basic principle of Profits Method
The value of the property depends on the profit generated from the business, not the physical building or location.
Must have accurate and audited accounts for 3 years if possible, or estimates/ business plan for new business.
Simple methodology for Profits method
1) annual turnover (Income received)
- Less costs/purchases
= Gross profit
- less reasonable working expenses
= unadjusted working expenses
- less operator’s remuneration
= adjusted net profit, known as Fair Maintainable Operating Profit (FMOP)
What is another name for the Depreciated replacement cost method (DRC)?
Contractor’s method
When is the only time you would use the DRC method?
It should only be used where direct market evidence is limited or unavailable for specialised properties.
Specialised properties could include Sewage works, lighthouses, oil refineries, docks, schools, a submarine base etc.
Purpose of the DRC method
Used for Owner occupied property
For accounts purposes for specialised properties
Also used for rating valuations of specialist properties
Simple Methodology of DRC method
1) Value of land in its existing use (assume planning permission exists)
2) Add current costs of replacing the building plus fees, less a discount for depreciation and obsolescence/deterioration. (Use BCIS and then judge level of obsolescence).
what is physical obsolescence
What is Functional obsolescence
What is Economic obsolescence
DRC method and Red Book Compliance
the DRC method is not suitable for Red Book Compliant valuations for Secured Lending Purposes.
It can be used for the calculation of Market Rent for specialised properties only for valuation for financial statements.
RICS Guidance Note of DRC
Depreciated replacement cost method of valuation for financial reporting, 2018
Red Book Official title
RICS Valuation - Global Standards 2021 (‘Red Book Global’
Structure of the Red Book
Part 1 - Introduction
Part 2 - Glossary
Part 3 - Professional standards (PS)
Part 4 - Valuation technical and performance standards
Part 5- Valuation applications (VPGA)
Part 6 - The International Valuation Standards (IVS)
Key changes from the 2017 Red Book
Need for compliance with the Red Book and adequate terms of reference to reflect this (PS 1 and VPS 1)
Terms of Reference must be clear and unambiguous in that vals are either Red book compliant or not.
Valuations for financial Reporting purposes (VPGA 1)
Reference to use of the profits method for certain trade related property valuations(VPGA 4) - non exhaustive list includes self storage, flex work and purpose built student housing
Sustainability and ESG factors particularly regarding - THIS IS PARTICULARLY IMPORTANT
- definitions
-inspections and reporting
-Vals for secured lending purposes
-Direct and indirect Valuation relevance, and physical and transition risks (VPGA 8).
Definitions and scope of vals contained within the International Valuation Standards (IVS).
Popular Red Book questions
When is the Red Book used?
The contents of the terms of engagement and reports?
Definitions of the Bases of value?
Secured lending Valuations?
When is the Red Book Used?
Mandatory for all valuations except for the 5 exemptions.
What are the 5 exceptions to using a Red Book Valuation (Must know) PS1
1) Advice is provided in preparation or during course of negotiations or litigations
2) The Valuer is performing a statutory function (except for the provision of a valuation for inclusion in a statutory return to a tax authority)
3) The valuation is provided for a client purely for internal purposes (w/o liability, and not communicated to any 3rd party)
4) Valuation is provided as part of agency and brokerage work in anticipation of receiving instructions to dispose/acquire an asset. (except when a purchase report is required inclu. a val)
5) the Val advice is provided in anticipations of giving evidence as an expert witness
Difference between Internal and External Valuer
Internal is employed by the company who hole the assets, vals are for internal use only and no third party reliance.
External - no material links with the asset to be valued
Before commencing a Valuation Instruction, what 3 steps should you consider?
- CIT
- Competence - am I competent to undertake the work? necessary skills etc
-Independence - Think first, then check for any conflicts - Terms of Engagement
