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APC Spring 2024 > Valuation > Flashcards

Valuation Flashcards

1
Q

What are the five methods of valuation?

A
  1. Comparable
  2. Profits
  3. Depreciated Replacement Cost
  4. Investment
  5. Residual
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2
Q

What steps would you take when carrying out a comparable method valuation?

A
  1. Look at the subject property
  2. Select comparables
  3. Analyse comparables
  4. Display in matrix/table
  5. Value the subject property
  6. Stand back and look
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3
Q

Why do we carry out adjustments?

A

To express the comparable in terms of the subject.

E.g if the comparable is in a poorer location than the subject, I would say what it would sell for it was in the same location as the subject.

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4
Q

What sort of details would you include within a matrix/table?

A
  1. Subject property address
  2. Comparable property addresses
  3. Size of both subject and comparables (IPMS or COMP)
  4. £/sqm
  5. Date
  6. Location
  7. Layout
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5
Q

What is the RICS publication in relation to comparable evidence?

A

Comparable evidence in Real Estate Valuation - 1st edition published in October 2019. It is a Guidance Note

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6
Q

What does the Guidance Note “Comparable evidence in Real Estate valuation, 1st edition” detail?

A
  1. Sources for comparable evidence
  2. Hierarchy of evidence
  3. Recording of comparable evidence
  4. Comparable evidence analysis
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7
Q

What are the steps that you would take to carrying out a Profits method valuation to arrive at a Capital Value?

A
  1. Get 3 years accounts (for audit and consistency)
  2. Work out the fair maintainable trade
  3. Deduct costs and expenses to get to the fair maintainable operating profit for a reasonably efficient operator
  4. Multiply the fair maintainable operating profit by an appropriate YP from benchmarks to get the Capital Value
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8
Q

What are the steps that you would take to carrying out a Profits method valuation to arrive at a Rental Value?

A
  1. Get 3 years accounts (for audit and consistency)
  2. Work out the fair maintainable trade
  3. Deduct costs and expenses to get to the fair maintainable operating profit for a reasonably efficient operator
  4. The Fair Maintainable Operating Profit then becomes the divisible balance
  5. Split the divisible balance between the Landlord and the Tenant to arrive at the Rental Value
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9
Q

What is the hierarchy of evidence for weighting comparables?

A
  1. New letting
  2. Lease renewal
  3. Rent review
  4. Independent expert
  5. Opinion
  6. Arbitration / court decisions
  7. Asking rents
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10
Q

What is the difference between the DRC and Contractors method of valuation?

A
  1. Contractors is used for Rating to establish a Rental Value where as the DRC Method is used to establish a Capital Value.
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11
Q

What is the Depreciated Replacement Cost (Contractors) method of valuation also known as?

A

The method of last resort

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12
Q

What are the steps you take to carry out a DRC valuation to arrive at a Capital Value?

A
  1. Establish replacement cost modern equivalent
  2. Depreciate for age and obsolescence (functional, technical and economical)
  3. Add site value

= Capital Value

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13
Q

What are the steps you take to carry out a Contractors valuation to arrive at a Rental Value?

A
  1. Establish replacement cost modern equivalent
  2. Depreciate for age and obsolescence (functional, technical and economical)
  3. Add site value
  4. Depreciate at statutory decap rate for Rating

= Rental Value

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14
Q

What is the statutory decap rate and who sets it?

A
  1. 5%
  2. 3.3% for health properties
  3. Central Government
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15
Q

What is a yield?

A

A measure of potential return on property investment through rent.

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16
Q

What is meant by investment with regards to the investment method of valuation?

A

To provide an income

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17
Q

What is meant by capitalisation with regards to the investment method of valuation?

A

To convert the income in to a capital sum

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18
Q

What is meant by decapitalisation with regards to the investment method of valuation?

A

This is where you can work out a rental income from a capital sum.

This is the converse of capitalisation and a division calculation.

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19
Q

What is the investment method of valuation?

A

This is the principle of converting a flow of income into a capital sum.

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20
Q

What is the key principle with regards to deferring/discounting?

A

That money in the future is worth less than money today.

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21
Q

What are some of the reasons why money is worth less in the future than today?

A
  1. You may not get it
  2. It can’t be invested elsewhere and produce an income if you don’t have it yet
  3. Inflation - Economy, goods and services will cost more in the future
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22
Q

What is the calculation for working out the value of money in the future?

A

Present value of £1 @ X%

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23
Q

What is the purpose of the Present value of £1 formula?

A

To establish how much less in the future £1 is worth.

This formula establishes the amount that needs to be invested now in order to accumulate at a rate of interest (i) for a number of years (n).

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24
Q

What is the amount of £1 compounding used for?

A

This is if you wish to know how much rent might go up at a specific rate (e.g. in using DCF).

This is used to calculate compound interest.

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25
Q

What is year’s purchase in relation to the investment method?

A

It calculates the present value of the right to receive £1 at the end of each year for a certain numbers of years at a given rate of interest.

It produces the capital equivalent from income for a given number of years.

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26
Q

Why is years purchase used commonly?

A

Because of various lease terms, income flows will start, stop and change.

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27
Q

What is the formula for years purchase?

A

YP x years @ X %

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28
Q

What is years purchase in perpetuity?

A

Years purchase in perpetuity is used where an income flow is fixed or perpetual. It’s also used where the property is at market rent because we don’t project rents in traditional investment valuation.

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29
Q

What is the formula for years purchase in perpetuity?

A

1 / i (or YP perp)

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30
Q

Why is the years purchase in perpetuity deferred for n years?

A

This is where the income or market rent will be some years away and received after a rent review.

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31
Q

When is years purchase in perpetuity deferred for n years most commonly used?

A

Within the term and reversion technique and is normally the present value of 1 multiplied by the year’s purchase in perpetuity.

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32
Q

What is the formula for Years Purchase in perpetuity deferred for n years?

A

YP perp def X years @ X %

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33
Q

What can affect the flow of income in an investment valuation and should always be considered?

A
  1. Lease terms
  2. Rent-free period
  3. Stepped rent
  4. Break clause
  5. Income risk
  6. Tenant covenant risk
  7. Economic and political risk
  8. Anything that may put the flow of income at risk
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34
Q

What kind of incentives would you expect in a growth market?

A

A premium being paid to the Landlord in addition to the rent

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35
Q

What kind of incentives would you expect in a static or declining market?

A

The Landlord would offer incentives the encourage the take-up of commercial property. E.g. rent free or stepped rent periods.

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36
Q

What is a headline rent?

A

This is what’s shown in the property press or letting details before any incentives are allowed.

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37
Q

Why might you expect a higher headline rent?

A

By maintaining a higher headline rent and offering incentives, this can help protect the capital value of a property as it may have less impact on yields if it can remain confidential.

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38
Q

What is the net effective rent?

A

This is where the headline rent is analysed to reflect the incentives. We analyse to arrive at a net effective rent.

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39
Q

How would you analyse a rent free period?

A
  1. Straight line method (simple maths, work out the total rent and the length of the lease, to arrive at a net yearly figure). Doesn’t consider the time value of money.
  2. YP method or discounted cash flow
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40
Q

What is the key document for analysing commercial lease transactions?

A

RICS UK Guidance Note 6 - The Analysis of Commercial Lease Transactions

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41
Q

How do you analyse a stepped rent?

A
  1. Straight line method - Add up the total rent received and divide by the length of the lease to calculate net effective rent
  2. YP method or discounted cash flow
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42
Q

What are yields used for in the investment method?

A

They are used to capitalise rents in valuation and decapitalise capital values in analysis.

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43
Q

What is an all risk yield?

A

This is a growth implicit yield and it takes account of risks, returns and expectations of growth.

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44
Q

What are some examples of all risk yields?

A
  1. Net initial yield
  2. Gross initial yield
  3. Equivalent yield
  4. True equivalent yield
  5. Reversionary yield
45
Q

What is a gross initial yield?

A

This is the simplest yield and is the income as a percentage of the capital value

46
Q

What is a net initial yield?

A

This yield is calculated from a transaction, expressing the income as a percentage of the capital value but reflects the purchasers costs

47
Q

What is an equivalent yield?

A

This is the weighted average yield between the term and reversion or sometimes also called the internal rate of return with no growth.

48
Q

What is a true equivalent yield?

A

Valuation formulae and most traditional valuation tables assume income is received annually in arrears.

This yield takes in to account an actual payment pattern such as quarterly and therefore the time value of money in the calculation.

49
Q

What is a reversionary yield?

A

If the rent is likely to change at reversion, then the yield is likely to change too.

This yield reflects the risk, return and expectations of growth at the future rent review or renewal.

50
Q

What is an equated yield?

A

This is the discount rate in a discounted cash flow and the internal rate of return WITH allowance for growth. It represents the investors total return.

This yield is NOT an all risk yield because it is growth explicit!

51
Q

Is the reversion safer or riskier than the term?

A

Riskier!

52
Q

What is a general rule of thumb for adjusting yields between term and reversion?

A

The term is under rented and therefore less risky, therefore adjust by 0.5% to 1% depending on the length of time and degree of under renting.

53
Q

How do you calculate a net initial yield?

A
  1. Gather comparable transactions
  2. Divide the rent by capital value plus costs
  3. Express as a percentage (multiply by 100)
54
Q

What is a useful percentage figure to use for calculating costs when working out a Net Initial Yield?

A

6% with the breakdown being:

4% - stamp duty

1% - agents fees

1.5% - legal fees

0.5% - VAT on fees

55
Q

What is the term and reversion technique?

A

It is a technique of the investment method of valuation to value a property that is let at less than the market rent

56
Q

What are the two stages of a term and reversion valuation?

A
  1. Term
  2. Reversion
57
Q

What happens in the Term stage of a Term and Reversion valuation?

A

You use the income flow for the term to calculate a capital value

58
Q

What happens in the Reversion stage of a Term and Reversion valuation?

A

You value the market rent into perpetuity and bring it back to todays value using the present value of £1

59
Q

Is the term and reversion technique growth implicit or growth explicit?

A

Growth implicit. We don’t increase more than the current market rent. If the rent is expected to grow this is reflected in the yield.

60
Q

If you want to reflect growth in a valuation, what valuation method would you use?

A

Discounted cash flow

61
Q

How is growth reflected within a term and reversion valuation?

A

An investor would expect to see a lower yield to reflect rental growth. The lower the yield the better the prospects.

62
Q

What are the steps for a term and reversion valuation?

A
  1. Identify the income flow using the passing rent from the lease, market rent from comparables and also when the reversion is coming or any income changes)
  2. Capitalise the term passing rent using a years purchase calculated from comparable yield analysis for the number of years it is received.
  3. Capitalise the reversion and defer using the Present value of £1. Using a yield derived from comparable analysis that reflects risk, capitalise the market rent in to perpetuity and defer using the present value of £1 to bring it back to today’s value.
  4. Add the term and reversion capital figures together to give a single capital sum.
  5. Stand back and look to check the valuation for any potential errors.
63
Q

What are the four residential market sub sectors?

A
  1. Owner occupied
  2. Private rented sector
  3. Social housing
  4. Holiday home sector
64
Q

What are some drivers of value in the residential market?

A
  1. Location
  2. Size
  3. Accommodation
  4. Quality
  5. State of Repair
  6. Potential to develop
  7. Natural hazards
65
Q

What are some drivers of value in the commercial market?

A
  1. Economy
  2. Business
  3. Technology
  4. Statute
66
Q

What are the two sub-markets for office properties?

A
  1. Prime - Best quality property and tenants are found, with the address conferring status
  2. Secondary - Better value location with lower rents and higher yields. Offices normally lower quality but secondary refers more to the location
67
Q

What are the three categories of office specification and what would you find within each?

A

Grade A - Raised floors, suspended ceilings, lift, air conditioning

Grade B - Fall below Grade A, maintained to a good standard with adequate facilities

Grade C - Functional space, lower quality than A and B

68
Q

What are serviced offices / business centres?

A

These are managed premises specifically designed with infrastructure in place that caters to everyday business needs. Flexible rental terms.

69
Q

What are the two main markets for industrial properties?

A
  1. Factories - Where a process is carried out, such as steelworks. Natural resources and labour are key drivers of value.
  2. Warehouses - Used for storage. Eaves height and transport links are key drivers of value.
70
Q

What are the main retail market sectors?

A

Prime - Highest value and highest footfall location

Secondary - Less good location

Tertiary - Poor trading position

71
Q

What are some of the key clauses in a lease?

A
  1. Rent review
  2. Payment pattern
  3. Length of lease
  4. Break clause
  5. Statutory protection
  6. Alienation
  7. User clause
  8. Repairing clause
  9. Service charge
72
Q

What is the key driver of value in the commercial market?

A

The lease terms

73
Q

What is the comparable method of valuation?

A

The simplest approach of valuation based on comparing similar property transactions.

74
Q

What is the comparable method of valuation based on?

A

It works on the substitution principle that the value of one property can be derived by comparing it with prices achieved from similar property transactions, because a buyer will not pay more than the cost of acquiring an equivalent substitute

75
Q

What are the steps for carrying out a valuation by the comparable method?

A
  1. Look at the subject property
  2. Search for comparables
  3. Adjust and analyse comparables
  4. Value the subject property
  5. Stand back and look
76
Q

What does the comparable method rely on?

A
  1. Information - the availability of it is essential
  2. Transactions - high volume available
  3. Stability - more reliability in a stable market
77
Q

When should you use the comparable method?

A
  1. Whenever there are comparable transactions available, like in the residential market
  2. As a cross-check with the other methods of valuation?
78
Q

What are some examples of a good comparable?

A
  1. Comprehensive (all details available)
  2. Verifiable
  3. Similar
  4. Recent
  5. Arms length
  6. Consistent with market practice
79
Q

What is a matrix?

A

A matrix is a table to list and comparable comparables

80
Q

What are some comparison factors you’d include in your matrix for a residential property?

A
  1. Style
  2. Site
  3. Location
  4. Size
  5. Bedrooms
  6. Age and condition
  7. Fixtures and fittings
  8. Car parking
81
Q

What are some comparison factors you’d include in your matrix for an office property?

A
  1. Layout
  2. Flexibility
  3. Floor area (quantum)
  4. Building services
  5. Specification
  6. Transport facilities
  7. Lease terms
82
Q

What are some comparison factors you’d include in your matrix for a retail property?

A
  1. Building layout
  2. Size
  3. Height
  4. Loading
  5. Access
  6. Car parking
  7. Visibility
  8. Lease terms
83
Q

What are some comparison factors you’d include in your matrix for an industrial property?

A
  1. Accessibility to the major road network
  2. Site access and loading
  3. Building layout and height
  4. Floor loading
  5. Layout offering clear space
84
Q

What are some key bits of information you’d make note of when finding comparable evidence?

A
  1. Address
  2. Property type
  3. Freehold or leasehold
  4. Location
  5. Lease details
  6. Property details
  7. Type of transaction
  8. Date of transaction
  9. Source of information
  10. Analysis per unit area
  11. Measurement
85
Q

How do you carry out adjustments after collating your comparable evidence in a matrix?

A

Use percentage adjustments that come from market analysis.

Also use the £/sqm and £/sq ft to make adjustments

86
Q

When would you use the comparable method?

A

If there is an active market and suitable transactional evidence

87
Q

When would you use the investment method?

A

If there is an income flow and the property is purchased as an investment

88
Q

When would you use the residual method?

A

If there is development potential

89
Q

When would you value by the profits method?

A

Where it is not possible to value by the comparable or investment method due to a lack of comparables and there being no rent to capitalise.

90
Q

When would you value by the DRC method?

A

Where it is not possible to value by the comparable or investment method due to a lack of comparables and there being no rent to capitalise.

91
Q

What is the principle behind the Profits method?

A

That the value of the property is related to its earning capacity

92
Q

What are some examples of property types that you would value by the profits method?

A
  1. Pubs
  2. Nightclubs
  3. Hotels
  4. Cinemas
  5. Petrol stations
93
Q

What are some property types which you would value it by the DRC method?

A
  1. Schools and universities
  2. Museums
  3. Fire and police stations
  4. Town halls
94
Q

What is the principle behind the DRC method?

A

If the subject property was not available, the owner would have to acquire a new site and construct new buildings to provide a service or keep the business operational.

95
Q

What are the steps to carrying out a Profits method valuation?

A
  1. Establish estimated gross earnings
  2. Deduct purchase and expenses to establish net profit
  3. Multiply by a suitable gross initial yield
  4. Stand back and look
96
Q

What are the steps to carrying out a DRC valuation?

A
  1. Find the estimated replacement cost of a modern equivalent building.
  2. Depreciate the cost to reflect the disadvantage of the actual property in terms of age and obsolescence.
  3. Add the land value, sourced from comparables.
  4. Stand back and look.
97
Q

Where would you find the replacement cost for a building in a DRC valuation?

A

Using cost guides such as the RICS BCIS pricing books or from other professions

98
Q

How much should you depreciate by in a DRC valuation and how is it done?

A

Depreciation is a straight line percentage deduction. Roughly 1% per year

99
Q

Where should you look for land value comparables in a DRC valuation?

A

You should find comparable land transactions from usual sources such as databases and records like CoStar. Location will be a key factor.

100
Q

What are some drawbacks of the DRC method?

A
  1. Cost doesn’t equal value - think of the bigger picture
  2. Depreciation factor - difficult to establish
  3. Land value - location is everything
  4. Reasons for occupation - viewing the occupation from a financial perspective can distort the useful and efficiency of the occupation
101
Q

What are some drawbacks of the Profits method?

A
  1. Accounts - getting the right accounts to value can be challenging
  2. Years purchase - difficult to establish
  3. Specialists - required to do these valuations
  4. Reasonable man - must know if it’s over trading!
102
Q

What is the basic principle behind a DCF valuation?

A

The time value of money, presented in a table with income and expenses discounted

103
Q

What is the target rate for a DCF?

A

This is also known as the discount rate, also known as an equated yield.

It represents the internal rate of return and is the equated yield where the net present value equals zero.

104
Q

What target rate would you use for a DCF?

A
  1. Analysis of comparable income flows
  2. Financial markets such as viewing government bonds
105
Q

What period would you use a DCF?

A

5-10 years is ideal

106
Q

For what basis would you use DCF valuations?

A
  1. Market value if the discount rate is the same as the market capitalisation rate
  2. Investment value or worth
107
Q

What is a YP in relation to the Profits method?

A

This is a financial capitalisation and not a market yield, which is calculated by:

YP = Fair maintainable operating profit / purchase price

Similar technique to calculating the Gross Initial Yield

108
Q

What are the three categories of evidence detailed in RICS comparable evidence in real estate?

A

Category A - Direct evidence

Category B - General market data

Category C - Other sources

APC Spring 2024 (18 decks)

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