Valuation Flashcards
Assumption
Matters that are reasonable to accept as fact without specific investigation or verification
Special assumption
Assumption that either assumes facts that differ from the actual facts at the valuation date or that would not be made by a typical market participant at the valuation date
Yield
Annual rate of return on an investment expressed as a percentage of the capital invested
Return
Expected rental and capital growth a purchaser will receive over the lifetime of an investment
Year’s Purchase
A yield expressed as a multiplier which tells the time it will take for a the purchase price of an investment to be paid back
All risks yield
Capitalisation rate which reflects all the prospects and risk attached to an investment, used in implicit valuation methods
Implicit assumptions within all risks yield
Tenant risk (lease renewal/default), lease risks, rental growth, capital growth, void risks, rent review mechanism, capital costs
Net initial yield
Current rent divided by gross value, adjusted for purchaser’s costs (SDLT, agency, legal fees)
Reversionary yield
Market rent divided by gross value
Equivalent yield
Blend of yields throughout the cash flow (time weighted average)
Running yield
The yield at one moment in time
Discount rate
The rate used when calculating the present value of future cash flows (reflecting market and property specific risks)
IRR
The single discount rate that must be applied to a series of future values to bring them back to a specified present day purchase price (discount rate for which with NPV equals 0)
Present value
Current worth of a future sum of money
Headline rent
Contracted paid rent
Net effective rent
Average contracted rent per annum over the term certain when accounting for incentives (industry standard to exclude the first 3 months of rent free for fit out time)
Specialised property
A property rarely if ever sold in the market expect by way of sale of the business or entity of which it is part due to the uniqueness arising from specialised design, configuration, size, location of otherwise
Hope value
An element of market value in excess of the existing use value reflecting the prospect of some more valuable future use
Marriage value
An additional element of value created by the combination of two or more assets or interests where the combined value is more than the sum of the separate values
Investment method of valuation
Used where there is an income stream and rental income is capitalised to produce a capital value
Hierarchy of evidence
Category A - direct comparables
Category B - general market data (published databases, indices, demand/supply data)
Category C - other sources
Term and reversion
Term rent is capitalised until the next lease event at an initial yield. The reversion to market rent is capitalised into perpetuity an all risks yield
Layer and hardcore
Income flow is divided horizontally. The bottom slice which is the rent passing if the asset is reversionary and the market rent of the asset is over rented is capitalised at a lower rate to reflect the lower risk. The top slice which is less secure is capitalised at a higher rate
Discounted cash flow
Financial modelling technique in which future inflows and outflows of cash associated with an investment, including the exit value are expressed in present day terms by discounting
How do you run a discounted cash flow
Estimate the cash flow (income less expenditure)
Estimate the exit value at the end of the holding period (usually using conventional ARY)
Select the discount rate (based on risk free rate + market risk + growth)
Discount the cash flow at the discount rate
Value is the sum of the completed discounted cash flow providing NPV
Methods for choosing a discount rate
Comparable evidence (can be challenging to get), market sentiment and understanding where your asset fits within an investors risk profile, hurdle rate based on specific investors requirements, cumulative method where you start with a risk free rate based on government bonds then add property risk and market risk
Advantages and disadvantages of DCF
It is explicit, transparent, useful where there is little market evidence and where there is complexity
It is complicated, open to interpretation and can become very subjective, forecasting can lead to uncertainty and lack of reliability
How would you do a profits valuation
I don’t have experience myself but am aware of the steps
Need 3 years of audited accounts
Analyse the accounts to establish a Fair Maintainable Turnover - considering whether the income and expenses reflect a typical business of that kind for example whether turnover could be improved with better management
Deduct costs to give a Fair Maintainable Operating Profit
Capitalise the profit at an appropriate yield based on market evidence
What are the main components of a DRC
Calculate the cost of constructing a substitute building - the modern equivalent asset reflecting any optimisation
Depreciate based on physical, functional and economic obsolescence
Calculate the land value - considering whether current site is still the most appropriate
Add the depreciated cost and land value together
Purpose of the Red Book Global
Consistency, objectivity and transparency fundamental to building public trust and confidence in the profession
Changes to the Red Book Global 2021 (effective 31 Jan 2022)
PS1 - Clarification there is no partial red book valuation. No departures except the specified exemptions
VPS 2 - ESG factors to be considered as part of inspection process
VPGA1 - Additional wording to reflect IFRS 16 (entire value of leases reflected on balance sheet)
VPGA 2 - market influence of ESG should be considered e.g. cost to meet investor and regulatory requirements
PS 1 When does a valuation not have to be red book compliant?
Agency or brokerage
Acting as an expert witness
Performing statutory functions
Internal purposes
During negotiations or litigation
What are regulated purpose valuations
Published financial statements
For a Stock exchange or similar body
Publication or prospectus
Investment schemes
Take overs and mergers
What disclosures are required in the terms of engagement and report for regulated purposes valuations where the asset has previously been valued by the firm or valuer (PS 2)
Relationship with the client and previous involvement
Rotation policy
Time as signatory
Proportion of fees
What must be included in terms of engagement (VPS 1)
Identification and status of the valuer
Identification of the client
Identification of other intended users
Identification of the property
Currency
Purpose
Basis/bases of value
Valuation date
Nature and extent of investigations
Assumptions and special assumptions
Format of report
Restrictions on use and publication
Confirmation that valuation will be undertaken in accordance with the IVS
Fee basis
Reference to CHP
Limitations of liability
Mandatory contents of a valuation report
Identification and status of the valuer
Identification of the client and other intended users
Purpose
Identification of the property
Basis/bases of value
Valuation date
Extent of investigation
Assumptions and special assumptions
Restrictions on use, distributor and publication of the report
Confirmation that valuation has been undertaken in accordance with the IVS
Valuation approach and reasoning
Amount of valuation
Date of the valuation report
Commentary on any material uncertainty
Limits to liability
Market Value
The estimated amount for which an asset or liability should exchange at the valuation date between a willing buyer and willing seller in an arm’s length transaction and where the parties had each acted knowledgeably, prudently and without compulsion
Market rent
The estimated amount for which an interest in real property should be leased on the valuation date between a willing lessor and willing lessee on appropriate lease terms in an arm’s length transaction after property marketing and where the parties had each acted knowledgeably, prudently and without compulsion
Investment value
The value of an asset to a particular owner or prospective owner for individual operational objectives
Fair value
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
What should you look for on inspection (VPGA 8)
Characteristics of the local area and the availability of services/facilities
Characteristics of the property and its use
Dimensions, areas and use of the constituent elements
Age, construction and nature of the building
Accessibility for occupiers and visitors
Amenities and services
Apparent state of repair and condition
Any hazardous materials/waste management
Natural hazards
Non natural hazards e.g. contamination
Potential for development or redevelopment
UK VPS 3 when can’t you proceed with a regulated purpose valuation?
If the property was acquired by the client in the last 12 months and the valuer or firm received an introductory fee or negotiated the purchase on behalf of the client
What are some key requirements of VPGA 2 Valuation of interests for secured lending
Conflicts of interest confirming no involvement with the borrower
Reporting requirements:
Provisionally agreed price or recent transaction included and the extent to which property was marketed
Comment on suitability for loan security including marketability through the life of the loan
Any circumstances the valuer is aware of that could affect the price
Special assumptions and comment on material difference with or without
What does UK VPGA 6 cover?
Local government and central government accounting valuations and that these should disregard hope value
What are some key requirements of UK VPGA 10 Valuation for commercial secured lending purposes
Building on VPGA 2
Ensuring standard terms remain appropriate for each instruction
Status of the valuer should at a minimum be external
Clarifies it is wholly the responsibility of the lender to asses and make the ultimate decision on the suitability for loan security
Tenant covenant strength test
Net profit 3 times the rental liability for 3 consecutive years
Net asset value more than 5 times the rental liability
Key Pereira Gray Recommendations
Incorporation of DCF as the principal model for investment valuations
RICS should develop a time specific and mandatory procurement and rotation process for valuers
RICS should create a dedicated independently led valuation regulatory quality assurance panel under the jurisdiction of the Standards and Regulation Board
RICS should review post qualification requirements for valuers
What are the different types of section within the red book
Professional statement - centred on ethics and conduct and are mandatory
Valuation Technical and Performance Standards - common definitions and consistent approaches. Mandatory
Valuation Practice Guidance Applications - best practice guidance
When did the UK national supplement come into force?
14 January 2019
Key requirements of UK VPGA 1
Clarify with the client which reporting standard applies
IFRS 16
What does the Red Book say about desk top valuations?
In VPS 1 it states that the valuer should consider whether it is reasonable with regard to the purpose of the valuation. And that it must be explicitly stated in the ToE and report that the property hasn’t been inspected
How does Creditsafe establish the risk profile of a tenant?
Scores a number of factors including industry operating in, previous bankruptcy, the age of the company
Performs a solvency test - current assets divided by current liabilities. Ratio should be above 70% (0.7)
What is the disadvantage of using Creditsafe?
It uses previous year’s accounts so is lagging
It doesn’t include a lot of smaller companies
What does the Red Book say about rotation
For RPVs it should be at least every 7 years and the period will depend on the frequency of valuation, the existence of a valuation panel and other internal quality control procedures e.g. Director sign off and random internal audits
How do you calculate WAULT
Multiply the current rent by the remaining lease term for each of the tenants and then add these together. Divide the result by the total rent
What are the planned changes to MEES?
For all commercial let properties to be a minimum of E, not just for new lettings. This is anticipated to rise to C by 2027 and to B by 2030
What are the key drivers of yields?
Tenant risk (default), lease risk (rent review and term certain) letting risk/void risk, rental growth, capital growth
What is in your valuation file?
Due diligence e.g. flood risk check, environmental report, inspection photos, measurements, comparable evidence and notes of discussions with agents, terms of engagement, report, Argus valuation summary
What void holding costs are incurred on commercial property
Service charge shortfall (includes insurance and utilities)
Business rates
Letting fees on relet
What factors impact the value of a property?
Location
Layout and specification
Condition
Lease terms
Planning restrictions
Sustainability credentials/energy efficiency
Resi - aspect, amenities, schools
Retail - pedestrianisation, quality of surrounding occupiers
Office - facilities, proximity to transport
Industrial - connectivity to motorway network, age
What is the modern equivalent asset concept?
That a potential buyer would not pay any more to acquire the specialised asset being valued for more than the cost of acquiring an equivalent new one
Did you measure the mixed use office and retail building? How you measure and zone the retail?
I measured on an NIA basis
Including:
Area taken up by built in cupboards
The thickness of the display windows
Excluding:
Basement storerooms and staff rooms
Columns
Corridors
Stairwells
I then analysed the find the area ITZA from my plans
Zone A
Zone B - A/2
Zone C - A/4
Remainder - A/8
What is a GOAD map
Detailed street map including individual buildings and their uses
When valuing the mixed office and retail building what did you do about the one tenant that wasn’t very low risk? What did Creditsafe say about this tenant?
I made a 0.25% increase adjustment to the capitalisation rate for this tenant. Creditsafe deemed them moderate risk having low profit but high cash reserves
What did credit safe tell you about the national covenant at the Warrington industrial estate?
They were a subsidiary of Aviva Investors
760 employees
£25m net assets (against £54k rental liability)
What DD information do you collect when carrying out a valuation
Title - any easements or restrictive covenants
Leases/tenancy schedule
Asbestos register
Business rates
Contamination
Environmental matters e.g. flooding, power lines
EPC
Fire safety
Access/adopted roads
Public rights of way
Planning history and compliance
What is difference between what is incorporated within a discount rates vs an all risks yield?
Discount rate incorporates market risk and property risk
All risks yield also incorporates tenant risk, rent review mechanism, capital costs, void risks, rental growth, capital growth
What is the hierarchy of evidence in terms of the most common sources of comparable evidence
Open market
Lease renewals
Rent reviews
Third party determinations
Sale and leasebacks
Inter-company transactions
What does IRR show
It is the expected compound annual rate of return
What’s the difference between an IRR and discount rate
IRR is the discount rate at which the present value of all future cash flows is equal to the initial investment
Discount rate is the rate used when calculating the present value of future cash flows - representing required return based on market and property risks
What is weighting of comparable evidence
Ranking comparable evidence in accordance with relevance to the property and the hierarchy of evidence
What is a caveat
A warning of specific conditions or limitations
Capital expenditure
Money spent to buy, maintain or improve fixed assets like buildings or equipment
