Valuation Flashcards
When is the profits method used and how is this undertaken?
- The profits method is derived from trade related properties where the value is derived from the business and its trading potential
- This trading potential is the profit that a reasonably efficient operator would expect to realise from occupying the property
- Examples include hotels, schools, cinemas and theatres
- The common characteristics of these properties is where the property has been designed for a specific use and the value is linked to what the owner can generate from the property
- The value therefore reflects the trading potential of the property and it includes the property interest, business and locational good will and fixtures and fittings all reflected as a single figure
- The income and expenditure forecast is based on historical and comparable information
- The forecast represents the fair maintainable turnover and fair maintainable operating profit that a reasonably efficient operator would hope to achieve, which is a reasonably accurate forecast of the properties trading potential
- The actual performance is compared with similar trade properties to determine whether the fair maintainable turnover is realistic based on current market conditions
- The fair maintainable operating profit is capitalised at an appropriate rate of return to reflect the risks and rewards of the property to determine its trading potential. Evidence of accurate comparable market data should be analysed and applied
What is the depreciated replacement cost method of valuation and how does this work?
- It provides an indication of value based on the buyer paying no more or no less than the cost to obtain the asset based on the current equivalent
- This involves calculating the replacement cost of the asset with its modern equivalent including deductions for physical deterioration and all other relevant forms of obsolescence
- Method of last resort
- Used to value unusual properties where there is no active market e.g. mosques, schools or refineries
- The capital value is determined by calculating the cost of the building equivalent asset and the purchase land value
- The replacement build cost should be calculated using new and cost-effective building materials and techniques
- The total value of the new property is then adjusted for deterioration using evidential information and recent transaction values to calculate the land purchase cost
What is the comparable method of valuation and how does this work?
- It primarily uses sales data of properties that have recently sold focussing on assets that have a similar size, location, condition, features and specification
- It is underpinned by comparable evidence which is identified, analysed and applied to the real estate that is to be valued and is therefore fundamental to producing a sound valuation that can stand scrutiny from the client and market
- The valuer will compile a schedule of evidence that will contain details about the property such as age, quality, location, tenure, size, transaction price, date of sale, price per sq ft etc. all f which can be used for the purposes of comparison with other similar properties
- The comparables gathered should be comprehensive that is to say there should be several comparables rather than this being singular, they should be recent and representative of the current market conditions, very similar and consistent with local market practice
- See RICS Comparable Evidence in Real Estate Valuation 1st edn 2019
What is the investment method?
- It is when there is an income stream to value and you reflect the level of risk in the yield
- Traditional approach is growth implicit in the choice of yield whereas DCF (discounted cash flow) is growth explicit and the cashflow is explicitly modelled incorporating valuer assumptions
- If DCF is based on client data then it represents investment value, if based on market data then it is the market value.
What is the Red Book?
The RICS Red Book contains mandatory rules and best practice guidance for members who undertaken asset valuations. It includes:
- International Valuation Standards
- Red Book UK - Issued since 2015
Key Sections of the Red Book include:
- Introduction
- Mandatory Valuation Standards
- Advisory Valuation Standards
- Valuation for Financial Reporting
- Valuation for Charity Assets
- Valuation for commercial secured lending purposes
- Valuation for compulsory purchase and statutory compensation
Are there plans to amend the Red Book in 2024?
Yes, the Global Red Book is being updated through 2024.
- New International Valuation Standards (IVS) were published 31 January 2024.
- It will be updated to reflect:
- implementation of Valuation Review recommendations
- practice and process changes driven by evolving areas such as ESG and technology
- information related to developments in other relevant global standards and regulation such as IFRS and Basel 3.1
- administrative updates to align the standards with wider RICS objectives.
The draft timeline for updates is currently early summer 2024 consultation, autumn 2024 publication with an effective date of 31 January 2025 for alignment with IVS.
What steps would you take following your valuation instruction?
- Obtain details of the property
- Undertake a conflict of interest check
- Obtain a signed letter of instruction
- Confirm the purpose of the valuation
- Undertake information gathering including confirmation of the purchase price
- Identify ratings, planning & environmental information
- Carry out the inspection and measurement of the property
- Research market values
- Compile the valuation report
- Check valuation internally including sign off with any relevant signatories
- Report to the client and address any queries
- Submit an invoice
What details would you expect to see covered in a Banks Letter of Instruction on a valuation for secured lending?
- Borrower
- Property
- Purpose
- Conflicts
- Details of loan
- Who the report is to be addressed to
- Special assumptions
- Details on where to get information and how to get access to the property
- What the report should contain e.g. areas, condition, tenancies/lease, environmental conditions, the market, relevant risks, valuation amount and any fees that are applicable
What are the 5 different methods of valuation?
- Comparable
- Income method
- Profits
- Residual
- DRC (depreciated replacement cost)
What does market value mean?
The estimated amount for which an asset should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion.
What does market rent mean?
The estimated amount for which a property, or space within a property should lease, on the date of valuation between a willing lessor and willing lessee on appropriate lease terms in an arm’s length transaction and after proper marketing wherein the parties had acted knowledgeably, prudently and without compulsion.
What is hope value?
- It is the term used to describe the market value of land based on the expectation of getting planning permission for development on it
- This differs from the existing use value which is what the land/property is worth in its current form
What is marriage value?
The extra value that arises from the merger of two physical or legal interests
What is special value?
An extraordinary element of value over and above the market value
What does TEGOVA stand for?
The European Group of Valuer’s Association
- Unites 70,000 national valuer’s associations from 38 countries
- The organisation seeks to make valuation compatible across the EU
- TEGOVA aims for a common European Valuation Report for Residential Property, new Guidance Notes and Information Papers on subjects of real interest to practising valuers and a comprehensive approach to valuation methodology including detailed exposition of key concepts such as income approach and depreciated replacement cost
What is the IVSC?
The International Valuation Standards Council
- It’s principle interest is to publish valuation standards and procedural guides for valuation of assets for financial statements
- The IVSC recognises the following International Valuation Standards:
– IVS1 - Market Value Basis of Valuation
– IVS2 - Valuation Bases other than Market Value
– ISV3 - Valuation Reporting - The IVSC also recognises two applications:
– IVA1 - Valuations for Financial Reporting
– IVA2 - Valuation for Lending Purposes
What is the difference between specialist properties and specialised properties?
Specialist = Trading properties such as hotels, cinemas, pubs where the property is designed to perform a specific purpose
Specialised = These include chemical plants and places of worship. These types of properties are very rarely sold on the open market except being exchanged within the industry or business they are a part of
What is the difference between Market Rent and Estimated Rental Value?
Market Rent = assumes vacant possession and is the amount of rent anticipated for the use of the property, in comparison with similar properties in the same area
Estimated Rental Value = takes into account further considerations about the property assuming the building is occupied e.g. there will be due consideration of the specific lease terms
When would you use Term & Reversion vs Hardcore?
These valuation approaches are utilised when the terms of the lease and incoming rental income are expected to change in the near future
What is the Term and Reversion approach?
- Used when the property has an existing lease in place that is due to expire
- The existing lease terms are considered separate from the expected new lease terms within the valuation approach
- In this instance the property is said to have reversionary potential taking into account the new lease terms
- In other words, the existing term is valued separately from the reversion (new lease terms)
What is the Hardcore/Layer approach?
- The layer or hardcore valuation method is used as an alternative to the term and reversion approach
- It considers the current market rent being received and applies this on a perpetual basis
- The difference between the current rent being received and expected market rent at the time of the lease renewal is also considered on a perpetual basis
- The two separate values are then added within the calculation
What is the definition of Equivalent Yield?
- It is a weighted average of the net yield from current rental income and all future reversionary income
- For example, if a 5% yield is applied on the hardcore rental income currently being received and a 6% yield is applied on future reversion income, the uniform equivalent yield would be weighted to consider both of the individual percentages being applied at 5.5%
- This approach is often simpler for valuers as they can apply a yield to the entire income stream rather than having to value hardcore and reversionary income separately
What is the definition of Equated Yield?
- It is the yield on a property investment which takes into account growth in future income
- This is not applicable to reversionary situations, where the increase in income on reversion is to the market value as estimated at the present time
What is Goodwill?
- An intangible asset when property or real estate is being sold or purchased
- It is a value within the transaction that is higher than the sum of the net fair value
- For example, the Goodwill portion of the transaction may be included due to special features of the asset being exchanged which may be associated with brand name, local customer base and excellent reputation
- The Goodwill element will create a special value over and above the value of the land or building being exchanged
What are the different types of Goodwill?
Purchased Goodwill
- Created when an asset is exchanged for an amount above the fair market value
- It is accounted for on a company’s balance sheet and is shown as an asset
- This is the only kind of goodwill that can be recognised on a company’s accounts
Inherent Goodwill
- Created over time as a non-measurable asset held by a property or company
- This can be derived from factors such as favourable location, excellent reputation, solid local customer base, good brand image and brand name
- Inherent Goodwill is not recorded on a company’s balance sheet as an asset and is only realised financially at the time the property or company in consideration is sold or exchanged
What is the difference between a residual valuation and a development appraisal?
- A development appraisal does not form part of a Red Book valuation standard whereas a residual valuation does
- Development appraisals are based on worth where one or more valuations are coupled with professional advice, analysis and opinion
- Development appraisals takes into account time (phasing) whereas residual valuation methods do not
- Development appraisals use client and agent input whereas residual valuations must use market lead inputs
- Development appraisals are used to determine whether profit levels are obtained at an acceptable level whereas residual methods are used to determine market value.
When would you use the Discounted Cash Flow valuation method?
- Where there are no comparable market transactions, the explicit DCF model provides a rational framework for the estimation of market value
- It can also be applied if there is expected short term market volatility present within the transaction for example if a tenant within a rental property is due to terminate their lease
- It can also be used if multiple investments are being compared side by side to support with long term investment decisions
- The estimated cash flows are projected over an assumed investment period in addition to an exit value at the end of the investment period
- The cash flow is then discounted back to the present day value at a discounted rate (also known as the desired rate of return) that reflects the perceived level of risk
- A discount rate is applied to reflect market and property-specific risks
- To arrive at the estimated revenue cash flow specific leasing patterns including rent reviews, lease renewals or re-lettings on lease expiry, void costs need to be considered
- The exist valuation needs to reflect the rental growth and unexpired terms of the leases at the exit date
- The assumptions and forecasts forming part of the calculation need to be set out clearly
How would you value a property where there are no comparables?
- DCF can be used where no comparable market transactions exist
- The estimated cash flows are projected over an assumed investment period in addition to an exit value at the end of the investment period
- The cash flow is then discounted back to the present day value at a discounted rate (also known as the desired rate of return) that reflects the perceived level of risk
- The assumptions and forecasts forming part of the calculation need to be set out clearly
What factors affect yields?
- Covenant
- Location
- Specification
- Rent levels
- Growth potential
- Asset management and development value
What are Face Rent and Effective Rent?
Face rent = A rent figure that excludes any incentives such as rent-free periods or rent reductions or fit-out contributions
Effective rent = Takes into consideration any incentives provided to the tenant such as to you as the tenant
What is the All Risks Yield (ARY)?
- The ARY presents the rental revenue of a property as an annual percentage of the property cost
- The ARY is calculated by dividing the annual rental income by the property’s value and multiplying this by 100 to give the percentage ARY
What are deleterious materials and how do they affect value?
- Deleterious materials are considered as prohibited and have an affect on the structural integrity performance and longevity of a property
- They can result in non-compliance with building regulations and decrease a property’s value
What are the main components of a valuation report?
- Tenure
- Date of valuation
- Extent of inspection and who inspected
- Opinion of value in words and figures
- Allowance for VAT
- 3rd party references
- Clause prohibiting publication
- External or independent valuer
- Date of report
- Statement that the valuer is qualified
How would structural defects be reflected in your valuation report?
- Draw client’s attention to them
- Advise them to have a structural survey done
- Can’t comment on area outside of one’s expertise
- Seek and obtain cost input to remediate and include within report
Are you allowed to know the purchase price when valuing?
- The valuer must request this and also verify it
- If your valuation differs you must state why
- This must be based on market evidence and bona fide
If you are found to be negligent in your valuation, what can your client do?
- The complainant can demonstrate the losses and pursue the valuer or valuing company through the courts for the losses incurred
- Merrett vs Bob case proved that valuers and not firms can be pursued
- This highlights the importance of having PII and run off cover in place
How would you rentalise the reception of an office building?
- 50% if single tenant
- Not at all if multi-let
What would you caveat in a valuation report?
- Publication
- Confidentiality
- Deleterious materials
- Planning
- Taxation
- Information supplied
- Environmental matters
What items are contained within the Terms of Engagement but not referenced within the valuation report?
Professional fees for undertaking the valuation
What is in your valuation report and not in your Terms of Engagement?
- Opinion of value
- Valuation approach
What is meant by the term ‘passing rent’?
- The annual rental income currently generated by a property as recorded on the balance sheet date
- The passing rent generated by the property on the balance sheet date may be more or less than the estimated rental value
- Passing rent excludes any rental income when a rent free period is in effect and is based on actual income received
Why does the report include an ‘opinion’ and not an actual valuation?
- Case law has found that providing valuations are in accordance with the RICS Red Book a value based on opinion cannot be wrong
- Providing that the valuation is found to be within reasonable tolerances the surveyor cannot be considered wrong in their opinion
- If the valuation was provided based on an actual value this would not necessarily be accurate and may leave surveyors open to be pursued through court action
What is the difference between and internal and external valuer?
Internal = Someone who undertakes a valuation for internal use only
External = Has no material links with the asset or client
What are the 3 valuation approaches?
Income = Converting future cash flows into a capital value i.e. investment method, profits method and residual method
Cost approach = Reference to the cost of an asset e.g. DRC method
Market approach = Using comparable evidence e.g. comparable method
