Valuation Flashcards
What is the full title of the Red Book?
RICS Valuation - Global Standards
When did current edition of Red Book come into force?
31 January 2022
Who are the International Valuation Standards Council?
- non profit organisation that set the global standards for valuation
- RICS are a member and sponsor of IVSC
What editions of the Red Book have been in effect during your training?
2020 and 2022
What is the purpose of the Red Book?
- consistency, objectivity and transparency
- ensures valuation anywhere in the world is in accordance with highest professional standards
- provides framework for uniformity and best practice
- ensures compliance with Rules of Conduct
What were the reasons for the 2022 Red Book update?
- reflect changes in IVS made by IVSC
- reflect progress in ethics and measurement
- more detail when applying exceptions to VPS 1 - 5
- improved definitions and commentary on ESG section in glossary
- clarify existing text
Purpose of U.K. National supplement?
- supplement Red Book
- ensured U.K. valuations are consistent with U.K. accounting standards
To what valuations does the Red Book apply?
All valuations unless listed as exception
What valuations are exceptions to the Red Book?
- Internal purposes
- Agency/brokerage work prior to acquisition or disposal instructions
- Statutory function
- Expert witness
- Negotiation or litigation
What valuations are carried out for Statutory Functions?
- lease renewal (see S34 of 1954 Act)
- rating
- compulsory purchase
Difference between valuation technical and performance standards (VPS) and valuation practice guidance applications (VPGA)?
- VPS mandatory
- VPGA advisory
Note: these are two elements that make up the Red Book
What are the consequences if valuer does not comply with VPS?
- RICS can take disciplinary action
- action depends on severity of breach
What are the consequences if valuer does not comply with VPGA?
- may get sued for negligence if giving advice
Note: even if complied with Red Book, can still be sued as could have used bad comparables etc
How is departure from the Red Book mandatory requirements possible?
- if inappropriate to comply with VPS 1 - 5
- if client agrees
EG if good reason not to enter the property
Exception vs Departure from Red Book
Exception = Red Book does not apply
Departure = Red Book does apply but valuer does not comply with mandatory requirements
What information is required to do a valuation?
- location
- type of property
Note: also need to know purpose of valuation and to check for conflict of interest
What do valuation files contain?
- conflict of interest check
- agreed terms of engagement
- inspection notes (photos, plans)
- comparable evidence
- valuation calculations
- valuation report
Main contents of terms of engagement?
- valuer name
- client name
- property address
- purpose of valuation
- basis of value
- date
- currency
- fee basis
- inspection and limitations
- assumption and special assumptions
- reference to CHP
- statement on PII
PS1 Red Book
Compliance with valuation standards within U.K. jurisdiction
(comply with U.K. law)
PS2 Red Book
Ethics, competency, objectivity and disclosures
(valuer must have appropriate experience, skill and judgement, and avoid conflict of interest)
How do you respond to request to value property for Pavement / Drive By / External assessment?
- if new building and you have floor plans, fine to go ahead
- if previously inspected, fine to go ahead
- if new instruction but no plans/leases to review then cannot go ahead
Note: this is still Red Book valuation, often carried out as re-valuation
Red Book Global Bases of Value
- market value
- market rent
- investment value
- fair value
U.K. Specific Bases of Value
- existing use value
- existing use value for social housing
- projected market value
Note: second two are residential ones
Basis of Value vs Method of Valuation
Basis of Value = Red Book definition of value
Method of Valuation = technique used to arrived at a figure that we would describe with a Basis of Value
What assumptions are made in producing a valuation?
- planning permission for existing use
- free from contamination and hazardous substances
- if any parts are covered, assume those areas are free from defects
Special Assumption
an assumption that assumes facts which differ from those existing at the date of valuation
Examples of Special Assumptions
- if property vacant, assume let on defined terms (and vice versa)
- if property being refurbished, assume refurb has completed
- if no planning, assume planning permission has been granted
Market Value definition
The estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arms length transaction after proper marketing where all parties have acted knowledgeably, prudently and without compulsion
Market Rent definition
The estimated amount for which an interest in real property should be leased on the valuation date between a willing lessor and a willing lesser on appropriate lease terms in an arms length transaction after proper marketing and where all parties have acted knowledgeably, prudently and without compulsion
Special Value definition
An amount that reflects particular attributes of an asset that are only of value to a special purchaser
Special Purchaser definition
A particular buyer for whom a particular asset has special value because of advantages arising from its ownership that would not be available to other buyers in a market
EG can pay more than market value or can participate in synergistic value (might own property A and want to buy neighbouring property B so can merge assets to get synergistic value)
Synergistic Value definition
The result of a combination of two or more assets where the combined value is more than the sum of the separate values
Marriage Value definition
An additional element of value created by the combination of two or more assets where the combined value is more than the sum of the separate values
What is ‘proper marketing’?
- selling property via most appropriate method of sale
- allowing property to be in market for appropriate period to get market value
- advertising property to the target market
What is ‘arms length transaction’?
- no connection or relationship between parties
When is market rent not appropriate as a basis of value?
- rent review (use definition of rent in lease)
- lease renewal (S34 of LL&T Act 1954)
When is fair value the appropriate basis of value?
- when valuations for accounting or financial reporting EG company accounts
- usually same as market value
What is a regulated purpose valuation (asset valuation)?
- used where public has interest or third parties rely on valuation
Note: RICS recommends rotation of valuer every 7 years to avoid influence from past valuations
Examples of regulated purpose / asset valuations?
- for financial statements (company accounts)
- for stock exchange listings
- for takeovers and mergers
- for collective investment schemes
- for unregulated property unit trusts
Note: asset usually valued annually or quarterly
Market Value v Existing Use Value
Market value takes into account highest and best use of an asset (development potential) whereas existing use value is value of building as it is
When do you use Existing Use Value?
- when valuing Local Authority and Central Government owner occupied properties
When is DRC used in asset valuations?
- for properties where there is not enough comparable evidence
- for specialised properties that would not sell other than as part of a sale of the business in occupation
What are situations that can adversely affect the certainty of a valuation?
- unusual property (unique characteristics)
- market volatility (covid, politics)
- lack of information (not inspected interior)
5 conventional methods of valuation
- comparative
- investment
- residual
- profits / accounts
- contractors / depreciated replacement cost
What are contemporary valuation techniques?
- new techniques
- discounted cash flows are used
What makes a property transaction comparable to the property being valued?
Similarities in terms of:
- physical characteristics
- location
- use
- tenure
- time scale
How many comparables are needed to produce a valuation?
- all the comparable evidence
- enough to establish a trend
What is the longest time period that a transaction could be accepted as being a comparable
- most recent comparables tend to hold most weight
- either pre/post covid
What is weighting of comparable evidence?
- attached most weight to comparables with most similarities
- subjective depending on valuer
What is the Hierarchy of Evidence?
ranking evidence by transaction type
- open market lettings
- lease renewals
- rent reviews
- independent expert determination
- arbitrator award
- sale and leaseback
What is interpolation?
Calculating a value between two points
Considered statistically safe
What is extrapolation?
Calculating a value outside known data
Considered statistically dangerous
What is the purpose of zoning?
Valuation technique to compare retail units with different frontage to depth ratios
What is the standard zone depth?
6.10m / 20ft
Note: 9.10m on Oxford Street as retail units are much larger
How do you assess the market rent of the first floor of a retail unit?
Zone A / 10 if used for retail
Note: if used as storage or accommodation then can use a rate independent of Zone A
How do you assess the market rent of a ground floor unit with a return frontage?
- corner unit
- if frontages have equal footfall then whole unit would become Zone A
- if frontages have unequal footfall, then common to add uplift where the return frontage exists
EG if return frontage covered all Zone A and half Zone B then could add 5% uplift to Zone A and 2.5% uplift to Zone B
How do you assess market rent of ground floor retail unit with two frontages / that is a through unit?
- Zone back from both frontages at same or different Zone A rates
- will be different rates if footfalls are different at each frontage
EG Zone back at £100/sqft from one frontage and £150/sqft from the other
How would you determine market value of investment property let on internal repairing terms?
- use investment method
- deduct outgoings (external repairs, insurance and management fees) to get the net rent
- capitalise the net rent
What factors make up the all risks yield?
- physical characteristics of building
- tenant covenant strength
- market rent
- other lease terms (unexpired term)
- anticipated rental growth (location)
What is the market capitalisation rate?
- another name for All Risks Yield
- rate at which the market capitalises the income
How would you value a greenfield site with planning permission for residential development?
- use comparable method if possible
- if not, use residual method
How would you carry out a residual valuation?
- take market value of completed development
- deduct development costs
- deduct developers profit
- this gives the land value
What costs did you deduct in your residual valuation?
- demolition costs
- site clean up costs
- building / construction costs
- fees for construction
- finance costs
- contingency
- agent and legal fees on disposal
- agent and legal fees on acquisition
- purchasers costs when buying site
How did you calculate developer profit in residual valuation?
- 15% of gross development value
- can also take 25% of total costs
Note: percentage increases when risk increases
What are the usual acquisition costs?
- purchase price
- stamp duty land tax
- agent fees
- legal fees
- VAT on agent and legal fees
Ransom Strip
strip of land that gives access to development land
Ransom Value
Value attributed to the ransom strip
How would you value a ransom strip?
- value at percentage uplift in value resulting from the owner of the land having access over the ransom strip
Stokes v Cambridge 1961
- compulsory purchase case
- 12.6 acres of farmland and 0.7 acre ransom strip
- held that value of ransom strip was 1/3 of uplift in value of development land
- 1/3 now accepted as industry standard
Name property types valued by profits method?
Leisure properties
- petrol station
- pub
- theatre
- golf course
- casino
Why are certain properties valued using the profits method?
Used when cannot separate property from its use
What is the basic approach to the profits method?
- take estimated annual turnover net of VAT
- deduct costs of generating turnover
- leaves net operating profit
- capitalise this
What valuation checks can be carried out on valuation produced by profits method?
- capitalise gross turnover (excluding VAT)
- capitalise the adjusted net profit
- use unit price per seat / bedroom
Explain the basic approach to the Depreciated Replacement Cost / Contractors Method
- take gross replacement cost of modern equivalent
- minus depreciation to get net replacement cost
- add site value to get DRC
What is a Replacement Cost Assessment for insurance?
- insures building so if damaged by fire / storm it can be demolished and rebuilt in accordance with current regulation
- takes into account professional fees
What costs are included in a Replacement Cost Assessment?
- demolition costs
- shoring up/weather protecting of adjoining buildings if they’ve been damaged
- build costs
- professional fees
Why is YP single rate table also know as PV of £1 per annum
- tells us PV of £1 to be received each year for given number of years
- shows that further we go into future, the lower the sum becomes in todays terms
What are the principle sources of investment?
- gilts
- equities
- properties
What is a bond investment?
- capital is fixed for a fixed period and you get a fixed return
What is the major attraction of property as an investment?
- can improve performance with proactive management
What is the major disadvantage of property as in investment?
- low liquidity - takes long time to buy/sell
- requires active management
- high transfer costs (agent/legal fees)
- not divisible
Gross Yield
rent expressed as percentage of purchase price
Net Yield
rent expressed as percentage of gross acquisition price (purchase price and costs like SDLT, agent and legal fees)
Quantify purchasers costs in percentage terms
SDLT:
- 0% if under £150k
- 2% on next £100k
- 5% if over £250k
Agent Fees - 1%
Legal Fees 0.5%
VAT - 20% (0.3% when of the 1.5%)
Total = 1.8%
What would you do if you had to value an investment property but could not find any evidence of yields?
Construct a yield
- use gilt yield (risk free investment) and add risk premium
- deduct growth
Note: no growth if in recession
ARY = gilt yield + risk premium - growth
How is rental/capital growth accounted for in conventional investment valuations?
It is included in All Risks Yield (implicit)
Reversionary Investment
Investment that is let at rent other than market rent (over rented or under rented)
What techniques can be used to value under rented reversionary investment?
- term and reversion
- hardcore / layer
Explain process of Term and Reversion technique
- Capitalise passing rent until review or reversion
- Take market rent to be received at review/reversion and then capitalise that into perpetuity
- Defer it further at PV of £1 for the period of the term
Note: if under rented, then term is capitalised at lower rate due to lower risk. If over rented, then term is capitalised at higher rent due to higher risk
Explain the process of the hardcore / layer technique
- Capitalise passing rent into perpetuity
- Take market rent at review/reversion and capitalise it into perpetuity
- Defer it back for the period of the term at a PV of £1 per annum
Note: if under rented, bottom slice capitalised at below market rate due to reduced risk and top slice capitalised at above rate due to increased risk. If over rented, then vice versa
How would you capitalise over rented investment?
- term and reversion or hardcore/layer
- capitalise all portions at above market rented rate
Initial Yield
Net income (passing rent) at date or purchase expressed as percentage of purchase price
Reversionary Yield
Market rent expressed as percentage of market value (purchase price)
Running / Straight Yield
Present income of property expressed as percentage of market value
Equivalent Yield
Weighted average of Initial/Running/Reversionary yields
- takes into account importance rather than treating all equally
- AKA Internal Rate of Return (disregarding rental or capital growth)
True Equivalent Yield
Yield taking into account that rent is received quarterly in advance, rather than annually in arrears (nominal yield)
Note: does not affect valuation
Equated Yield
Overall rate of return, taking into account growth
- true investment yield
- discount rate at which DCF equals purchase price of investment
Top Slice Income
- additional rent expected at review/reversion if under rented
- overage / froth if over renter
- leasehold profit rent
How is top slice income valued?
Capitalised above market rented rate to reflect increased risk
How do you value leasehold interest / ascertain if premium can be charged for assignment of lease?
- capitalise profit rent
Note: only has value if profit rent and unexpired lease term of more than 1 year
How do you capitalise the profit rent?
Via either:
- YP single rate
- YP dual rate
- YP dual rate tax adjusted
What are the names of the two yields in the YP dual rate?
- accumulative rate
- remunerative rate
Note: accumulative rate is sinking fund rate
What effect does rent received quarterly in advance have on the yield?
It increases it
- becomes true equivalent rather than nominal yield
Conventional Investment v Discounted Cash Flow
- growth implicit in capitalisation rate for conventional
- growth made explicit for DCF
(build in growth and calculate what future value will be - better option)
How is growth calculated in discounted cash flow?
- compound it using (1+n)^i
Or use Parry’s Amount of £1 Table
How do you arrive at discount rate when carrying out discounted cash flow?
- take gilt yield / risk free rate
- add risk premium (market risks and specific risks)
What is the risk free rate?
The yield from U.K. gilts
Name some purposes of valuation
- internal purposes
- taxation
- investment
- loan security
How may a conflict of interest arise in valuation?
Someone in same company as the valuer may be trying to sell the property
In the hierarchy of evidence, why is lease renewal above rent review?
- tenant can walk away and rent can go down (as well as up)
Where would sub-letting go in the Hierarchy of Evidence?
- if open market subletting then between open market letting and lease renewal
What is an appropriate capitalisation rate for an industrial unit?
Depends on:
- physical characteristics
- covenant strength
- lease term
- other terms
How do you capitalise an income stream to arrive at gross value?
Multiply by YP into perpetuity
How do you get from gross value to net value?
Deduct purchases costs
How do you carry out a valuation for vacant possession?
- use comparative method if possible
- use investment method if not
- use a high yield to take into account the risk, or reflect that there is a void period (term and reversion with void period of 6 months / 1 year)
What does BCIS stand for?
Building Cost Information Service
Note: owned by RICS
What do banks consider when calculating their lending rate?
Risk
Different types of funding available to a developer?
- Senior debt (6-7%)
- Mezzanine debt (8-10%)
Where does mezzanine debt sit in terms of charge?
Second charge (behind senior lender)
How do you present scenarios to your client after a residual valuation?
Sensitivity Analysis
Note: financial model where you can change input variables to see how outcome changes
Market Risks (in Risk Premium)
- illiquidity of sale
- lack of rental growth
- yield shift
- depreciation (economic/locational)
- legislative change
Specific Risks (in Risk Premium)
- covenant risk
- void risk
- management costs
- differing lease structures (rent reviews, break dates etc)
