Valuation Flashcards
What are the key comparative elements?
- building age and condition
- building spec and layout
- efficiency and adaptability
- legal
- limitations on use
- location
- size
- transaction date
What are the sources of comparable evidence?
Market evidence:
- direct transactional evidence
- publicly available info
(published by gov or e.g. real estate agents)
- published databases
(can provide a background to market trends)
- asking prices
- historic evidence
Indices:
- MSCI indices (cover principal commercial investment markets)
- larger firms of real estate advisors
- bdg cost data indices (for residuals)
AVMs
What is the hierarchy of evidence?
CAT A: direct comparables
- contemporary completed transactions for near-identical properties with full and accurate info
- similar real estate, enough reliable data
- similar real estate marketed, offers, not completed
- asking prices
CAT B: general market data
- info from published sources/commercial databases
- other indirect evidence (e.g. indices)
- historic evidence
- demand/supply data
CAT C: other sources
- transactional evidence from other real estate types and locations
- other background data (e.g. interest rates, stock, market movements)
What factors affect value?
- resi = location, aspect, outlook, physical condition, facilities
- retail = prime/secondary/tertiary, location, size, accessibility, parking ratio, tenant quality and mix, bdg quality
- offices = location, bdg quality, layout, facilities, service costs, bdg efficiency
- industrial = accessibility to transport links, bdg design, size, age, condition
- dev. potential = amount and density of permitted dev,
assumed value of completed dev,
ground conditions, dev costs,
allowance for risk, finance costs - investment: lease terms, break option, covenant, RR, tenure
How do you analyse a comparable?
- establish a common measurement or comparison standard
- analysis of the comparable data to provide meaningful comparable evidence (adjustments):
quantitative (cost of renovation)
qualitative (diff in location) - a matrix format often assists the valuer’s judgement
- valuer has to stand back and weigh up range of evidence
- requires technical ability and experience of relevant market and judgement developed from that experience- the process should lead to a ranking of the comparable evidence and an assessment of where the asset being valued fits into that ranking
How do you deal with a shortage of comparable evidence?
- the valuer has to look further afield and across a wider range of indicators when transactional evidence of direct comps lacking
- uncertainty generated by a lack of comp evidence is a common feature of the real estate market
- ensure the client understands this!
What is a comparable?
- an item of information used during the valuation process as evidence to support the valuation of another, similar item
- val of any asset relies on the economic principle of substitution
- ideally, comparable evidence should be:
comprehensive;
very similar;
recent;
the result of an arm’s length transaction in the market;
verifiable;
consistent with local market practice;
the result of underlying demand
Why might comparables not meet ideal criteria?
- a limited no. of available comparable transactions
- a lack of up-to-date evidence
- special purchasers
- a lack of similar or identical evidence
- real estate markets are not fully transparent
What valuation approaches might you use comparables in?
Market approach:
- adopts the principle that the value of one property may be derived by comparing it directly with market transactions of similar properties
Income approach:
- investment method
net rental income and a capitalisation factor
DCF key inputs inc rent, rental growth rate, discount rate
- profits method
assessment of a fair and maintainable level of trade
Cost approach:
- DRC 2 components: depreciated cost of bdg and val of land
What is a reversionary yield?
the Market Rent expressed as a % of the Purchase Price or Market Value
What is an initial yield?
the net income at the date of purchase expressed as a % of the Purchase Price
How did you/would you value an over-rented investment?
Term and reversion
- the term income has the higher risk
- the term income is capitalised at a higher rate than the reversionary income to reflect the risk
- the % uplift from the market-rented rate is a function of
the amount of over-renting
the time period until reversion to the market rent
the quality of the tenant’s covenant
if tenant of 1st class covenant, no risk so market rent rate
Hardcore
- the top slice income (overage/froth) is capitalised from now until reversion
Explain the process of the hardcore/layer technique?
(under-rented)
- the bottom slice of the income is capitalised at below the market-rented rate to reflect the reduced risk
- the top slice is capitalised above this rate to reflect the increased risk
Explain the process of the term and reversion technique?
(under-rented)
- the term is capitalised at a rate slightly lower than the market-rented rate to reflect the reduced risk
- the rent at review/reversion should arguably be an increased risk as it is not yet agreed
What techniques can be used to value an under-rented reversionary investment?
- term and reversion
- hardcore/layer
What is a reversionary investment?
A reversionary freehold is an investment that is let at a rent other than the Market Rent
- traditionally, under-rented
- can be over-rented
How is rental and capital growth accounted for in a conventional investment valuation?
Expectations of rental growth are not made explicit in the valuation but are implicit in the capitalisation rate
What would you do if you had to value an investment property but could not find any evidence of yields?
gilt yield + risk premium - growth rate
How would you carry out a diminution valuation in relation to a dilapidations claim?
usually carry out vals of property “in compliance” and “out of compliance” (not Red Book val)
- assess MV of property in each condition
- likely purchaser of property in each condition
- vals may be required for each scenario
- val date is termination date
- judgement as to whether items in SoD ind or cumulatively likely to affect value and how cost of remedial work is reflected in val if at all
What is “supersession” in relation to dilapidations claims?
e.g. where a LL completed remedial work that is grander than “basic”;
sometimes the LL’s claim could have been superseded
i.e. if the LL would still have undertaken the grander work or the market demands grander work be undertaken,
whereas at other times the LL would still be able to claim for the cost of basic remedials
What is recoverable under dilaps according to Dilapidations GN 2016?
typically the lower of the cost of the works and diminution of value of the LL’s reversion as a consequence of the T’s breaches
s18 of LTA 1927 limits the damages:
Limb 1: damages shall not exceed the amount by which the value of the reversion is diminished
Limb 2: no damage shall be recovered for a breach if the premises would at or shortly after termination be pulled down or structurally altered
(an example of “supersession”)
Why do property investors require a risk premium?
to adequately compensate them for the risk taken
What do you understand by the expression risk premium?
comprises Market Risks and Specific Risks
What is a risk-free rate?
the gross redemption yield on UK gilts
How would you arrive at a discount rate when carrying out a discounted cash flow?
The discount rate should adequately compensate an investor for the risk taken
- an adequate return can be calculated by taking a Risk-Free Rate and adding a Risk Premium
(gross redemption yield on UK gilts
+ Market Risks i.e. rental growth, structural change
+ Specific Risks i.e. covenant, lease structure)
How is growth calculated in a discounted cash flow?
The target rate/IRR/Equated Yield for growth-explicit calcs
The All Risks Yield/Market Cap Rate for growth-implicit calcs
What is the fundamental difference between conventional investment valuation techniques and discounted cash flow techniques?
With DCFs, assumptions about future cash flows are explicitly shown
What effect does rent received quarterly in advance have on the yield?
A nominal yield is based on rent being received annually in arrears
The True Equivalent Yield is the effective rate when rent is received quarterly in advance
It is slightly higher
What are the names of the two yields in the YP Dual Rate?
- The remunerative rate
(generally taken at 1% to 2% above the freehold market rent rate to reflect that - the profit rent is the top slice income
- the inconvenience of having a LL and a lease
- the difficulty of assigning/sub-letting near end of lease
- the poss of substantial liability for dilapidations)
- the accumulative rate
(the interest rate paid on the sinking fund element used to replace the capital outlay,
may be adjusted for tax)
How would you value a leasehold interest/ascertain if a premium can be charged for the assignment of a lease?
- a leasehold interest has a value when there is a Profit Rent (Market Rent less rent paid) and an unexpired term of at least 1 year
- a leasehold interest is valued by capitalising the Profit Rent by either:
the YP dual rate
the YP dual rate, tax adjusted, or
the YP single rate
How is top slice income valued?
For under-rented properties, a higher yield is applied to work out the YP to times the marginal income by to reflect the additional risk.
For over-rented properties, the froth is capitalised from now until reversion - again, a higher yield is applied.
What do you understand top slice income to be?
When a property is under-rented, it is the additional income to market rent.
When a property is over-rented, it is the amount it is over-rented by.
What is a true equivalent yield?
A nominal yield is based on rent being received annually in arrears.
The TEY is the effective rate when rent is received quarterly in advance.
What is an equated yield?
- The Internal Rate of Return with growth of a property investment
- the overall rate of return with growth, the true equivalent yield
- the discount rate at which the DCF equals the purchase price of the investment
i.e. the rate of which the NPV is 0 - can be calculated by Parry’s Internal Rate of Return table (reflecting projected Rental Growth)
What is an equivalent yield?
- the weighted average of the Initial Yield/Running Yield and the Reversionary Yield
- the internal rate of return from an investment disregarding any rental or capital growth
What are the VPS1 Terms of Engagement?
a. ID & status of the valuer
b. ID of the client(s)
c. ID of any other intended users
d. ID of the asset(s) or liability(ies) being valued
e. Valuation (financial) currency
f. Purpose of the valuation
g. Basis(es) of value adopted
h. Valuation date
i. Nature & extent of valuer’s work inc investigations and limitations
j. Nature & source(s) of info upon valuer will rely
k. All assumptions & special assumptions to be made
l. Format of the report
m. Restrictions on use, distribution and publication of the report
n. Confirmation that val will be undertaken in line with IVS
o. Basis on which fee will be calculated
p. Where the firm is registered by RICS, ref to complaints-handling procedure with a copy available on request
q. A statement that compliance with these standards may be subject to monitoring under RICS conduct and disciplinary regs
r. A statement setting out any limitations on liability that have been agreed
What are the components of a comparable?
- Address
- Real estate type e.g. office, shop
- Exact nature of the asset being valued or compared i.e. FH or LH
- Location details
- Legal e.g. lease terms
- Brief description, spec, condition and any other relevant attributes e.g. energy efficiency
- Accommodation/area - inc method of measurement
- Type of transaction e.g. sale, letting
- Date of transaction
- Financial info e.g. rent or sale price and any incentives
- Analysis per unit area (where appropriate)
- Parties involved e.g. owner, tenant, agents
- Source of info e.g. name, org, contact details
- Any comments on the reliability of data employed
- Date of confirmation of information
What are the components of a valuation report?
a. ID & status of the valuer
b. ID of the client & any other intended users
c. Purpose of the valuation
d. ID of the asset(s) or liability(ies) valued
e. Basis(es) of value adopted
f. Valuation date
g. Extent of the investigation
h. Nature & source(s) of the info relied upon
i. Assumptions & special assumptions
j. Restrictions on use, distribution & publication of the report
k. Confirmation that the valuation has been undertaken in accordance with the IVS
l. Valuation approach & reasoning
m. Amount of the valuation or valuations
n. Date of the valuation report
o. Commentary on any material uncertainty in relation to the valuation where it is essential to ensure clarity on the part of the valuation user
p. A statement setting out any limitations on liability that have been agreed
What is an assumption under VPS4?
- an assumption is made where it is reasonable for the valuer to accept that something is true without the need for specific investigation or verification
- any assumption must be reasonable and relevant having regard to the purpose for which the valuation is required
What is a special assumption under VPS4?
- a special assumption is made by the valuer where an assumption either assumes facts that differ from those existing at the valuation date or that would not be made by a typical market participant in a transaction on that valuation date
- where special assumptions are necessary in order to provide the client with the valuation required, these must be expressly agreed and confirmed in writing to the client before the report is issued
What is the income approach?
- based on capitalisation or conversion of present and predicted income (cash flows), which may take a number of different forms, to produce a single current capital value;
among the forms taken, capitalisation of a conventional market-based income or discounting of a specific income projection can both be considered appropriate depending on the type of asset and whether such an approach would be adopted by market participants
What is the cost approach?
- based on the economic principle that a purchaser will pay no more for an asset than the cost to obtain one of equal utility whether by purchase or construction
What are the valuation applications?
VPGA1: Val for inclusion in financial statements
VPGA2: Val of interests for secured lending
VPGA3: Val of business and business interests
VPGA4: Val of ind trade related properties
VPGA5: Val of plant and equipment
VPGA6: Val of intangible assets
VPGA7: Val of personal property, inc arts and antiques
VPGA8: Val of real property interests
VPGA9: ID of portfolios, collections and groups of properties
What does “Comparable evidence in real estate valuation” GN say about recording evidence?
NEED TO ADD DATE & EFFECTIVE DATE
- evidence used to arrive at an opinion of value should be recorded clearly and kept on file
- a tabular/spreadsheet layout is often appropriate
What is 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
(for most practical purposes consistent with market value)
What does VPS3 say about valuation reports?
- the report must clearly and accurately set out the conclusions of the valuation in a manner that is neither ambiguous nor misleading, and which does not create a false impression;
if appropriate, the valuer should draw attention to, and comment on, any issues affecting the degree of certainty, or uncertainty, of the val - the report must deal with all matters agreed between the client and the valuer in the terms of engagement
What is a basis of value?
- a statement of the fundamental measurement assumptions of a valuation
What is investment value?
- the value of an asset to a particular owner or prospective owner for individual investment or operational objectives
What standards must valuers comply with in “PS1 Compliance with standards where a written valuation is provided”?
- International Valuation Standards
- International Ethics Standards
- International Property Measurement Standards
- Compliance with jurisdiction or other val. standards (inc statement in ToE and report that the named standards have been complied with i.e. statutory requirements)
What does “PS2 Ethics, competency, objectivity and disclosures” require?
- must have appropriate experience, skill and judgement and must always act in a professional and ethical manner free from any undue influence, bias or conflict of interest (professional scepticism)
- must mention strict separation between advisers once “informed consent” obtained
- RICS considers good practice to rotate valuers at least every 7 years
Who are the valuation standards mandatory for?
mandatory to any member or firm undertaking or supervising val services by the provision of written valuation advice
(inc AVMs, exc insurance)
What are the exceptions to PS1?
- providing an agency or brokerage service
- acting as an expert witness
- performing statutory functions
- providing vals purely for internal purposes
- providing val advice expressly for negotiations/litigation/as an advocate
(as a matter of good practice, VPS1-5 should be followed where not precluded by the specific requirement or context)
What does VPS2 say about inspections and investigations?
- inspections and investigations must always be carried out to the extent necessary to produce a valuation that is professionally adequate for its purpose;
the valuer must take reasonable steps to verify the info relied on in the prep of the val and, if not already agreed, clarify with the client any necessary assumptions that will be relied on - any limitations or restrictions on the inspection, enquiry and analysis for the purpose of the valuation assignment must be identified and recorded in the ToE and also in the report;
any necessary assumptions or special assumptions made as a result of the restriction must be identified and recorded in the ToE and the report
What does VPS2 say about records?
- a proper record must be kept of inspections and investigations, and of other key inputs, in an appropriate business format
What does VPS2 say about revaluations?
- a revaluation without reinspection of an interest in real property previously valued by the valuer or firm must not be undertaken unless the valuer is satisfied that there have been no material changes to the physical attributes of the property, or the nature of its location, since the last assignment
What is the market approach under “VPS5 Valuation approached and methods”?
- based on comparing the subject asset with identical or similar assets (or liabilities) for which price info is available, such as a comparison with market transactions in the same, or closely similar, type of asset (or liability) within an appropriate time horizon
