Valuation Flashcards
What is the Red Book? (L1)
A comprehensive set of valuation standards and guidance notes to provide guidance when undertaking valuations
Current edition: RICS Valuation - Global Standards (took effect January 2022)
Why do we need the Red Book? (L1)
Provides guidance when undertaking valuation work
Impose mandatory obligations for competence, objectivity and transparency
Helps to support and achieve high standards of integrity and clarity
Establishes a framework for uniformity and best practice
Does not: instruct on how to value
What is the structure of the Red Book? (L1)
- Introduction
- Glossary
- Professional Standards (PS)
(mandatory) - Valuation Technical and Performance Standards (VPS) (mandatory)
- Valuation Applications (VGPA) (advisory)
- International Valuation Standards
What is the purpose of the Red Book? (L1)
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Purpose of the Red Book:
- Assure global valuation consistency, objectivity, and transparency.
- Adherence to the highest professional standards worldwide.
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Standards Provide:
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Mandatory Obligations:
- Competency
- Objectivity
- Transparency
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Framework for:
- Uniformity
- Best practice
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Compliance with:
- RICS Rules of Conduct
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Mandatory Obligations:
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Standards Do Not:
- Instruct on valuation methods.
- Prescribe a specific report format.
- Override local mandatory standards.
What are the 5 Conventional Methods of Valuation?
Investment
Comparable
Profit
Residual
Cost (Depreciated Cost Replacement - DRC)
What is the difference between an implicit and explicit investment valuation technique?
Implicit valuation methods employ all-risks yields as input yields with most real-life complications wrapped up into/implied in the input yield(s) chosen. An alternative approach is to make all the cash-flow assumptions explicit. This requires the investor and valuer to articulate all cash-flow assumptions and attitudes to risk. Such an approach tends to be more applicable to complex investments or markets in which sophisticated investors operate.
This methodology is usually referred to as a discounted cash-flow (DCF) method.
ARY reflects implicitly all future benefits and disadvantages of an investment.
What should you do before undertaking/accepting a valuation?
Check competency. Do I have the necessary skills, knowledge and experience to deal with this valuation
After confirming whether you are competent to undertake a valuation, what are the file contents?
After meeting the competency requirements, a Red Book Valuation and file contents are:
- Conflicts of Interest check
- Terms of Engagement
- Inspection notes etc.
- Planning, rating and environmental searches
- Comparables and analysis
- Valuation calculations with rationale
- Report
As per PS1, the Red Book applies to all valuations unless the purpose is specifically listed as an Exception. What are they?
- Agency or brokerage work in anticipation of disposal or acquisition instructions
- Acting or preparing to act as an expert witness (members must follow specific rules and procedures of the court, tribunal or other judicial body & must be impartial and objective)
- Performing statutory functions (for tax or rating purposes)
- Purely for internal purposes (not used by third party)
- Advice provided during negotiations or litigation
What are the Valuation Technical and Performance Standards? (VPS)
VPS 1 Terms of engagement (scope of work)
VPS 2 Inspections, investigations and records
VPS 3 Valuation reports
VPS 4 Bases of value, assumptions and special assumptions
VPS 5 Valuation approaches and methods
What are the main contents of the Terms of Engagement (VPS 1)
The Client
The Property or Asset
The Valuer
The Purpose of the Valuation
The Basis of the Value
The Method of Valuation
Currency
Valuation Date
Assumptions and Special Assumptions
Extent and Limitations of Inspection and Investigations
The Fee
Insurance
Complaints handling procedure
What is the Valuation Report section? (VPS 3)
This corresponds with the Terms of Engagement plus:
- Valuation approach and reasoning
- Amount of the valuation or valuations
- Date of the valuation report
- Commentary on any material uncertainty
What are matters that may give rise to material valuation uncertainty? (VPGA 10)
- Asset or liability specific characteristics
- Limited or restricted information
- Disrupted markets
What are the Bases of Value? (VPS 4)
- Market Value
- Market Rent
- Investment Value (or worth)
- Fair Value (IFRS definition)
What is Market Value? (VPS 4 Bases of Value)
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 arm’s length transaction, after proper marketing where the parties had each acted knowledgeably, prudently and without compulsion
What is an arm’s length transaction?
An arm’s length transaction refers to a business deal in which buyers and sellers act independently without one party influencing the other
What is Market Rent? (VPS 4 Bases of Value)
The estimated amount for which an interest in real property should be leased on the valuation date between a willing lessor and a willing lessee on appropriate lease terms in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion
What is Investment Value? (VPS 4 Bases of Value)
The worth of a property to a particular investor, or class of investors, for identified investment objectives
What is an Assumption?
Something that is likely to be true - although you may not be able to prove it. Include:
- Clean title
- Condition of buildings
- Services
- Planning (zoning)
- Contamination and hazardous substances
- Environmental matters
What is a Special Assumption?
Where an assumption assumes facts that differ from those existing at the valuation date. Includes:
- Planning consent has or will be granted
- Development completed in accordance with defined plan and specification
- Property changed in a defined way
- Property is vacant (when occupied)
- Property is let on defined terms (when vacant)
- Synergistic value is created
What are the Conventional Valuation Methods?
- Profits / Income / Account
- Investment
- Comparable / Comparative
- Residual
- Depreciated Replacement Cost
Contemporary techniques: DCF
What is the Hierarchy of Evidence?
For lease renewals and rent reviews:
- Open market lettings
- Lease renewals (above a rent review as rent can go up or down)
- Rent reviews
- Independent expert’s determination
- Arbitrator’s awards
Can you explain how only 3 years remaining on a lease can affect investment value?
- Increase Risk: Uncertainty about tenant renewal or re-letting.
- Lower Capital Value: Investors may demand a higher yield, reducing value.
- Potential Void Periods: Risk of vacancy and additional re-letting costs.
- Reduced Income Security: Less attractive to investors seeking stable, long-term income.
Is it better to have a higher rent let to a lower covenant or better covenant with lower rent?
Depends on the extremities of each and requirements of the client
How is the profits method calculated?
Annual t/o
Less costs and expenses = gross profit
Less working expenses = unadjusted net profit
Less tenants share = adjusted net profit / EBITDA
Capitalised at an appropriate yield
How would you value a retail building?
Investment method
How would you go about calculating the market rent for a retail unit?
Use comparable evidence to find an appropriate rent on a Zone A basis
How does Zone A work?
Halfing back principle, 6m depth, unit of comparison
When would you use the residual method of valuation?
The residual method of valuation is used when valuing development land or property with potential for redevelopment. It is typically applied in situations where the value is based on the potential future use, such as:
- Development Land: To determine the land’s value by calculating the potential gross development value (GDV) of a proposed project and deducting costs like construction, fees, and profit.
- Redevelopment Projects: To assess the value of properties that could be redeveloped for a higher use, such as converting an old building into residential flats.
The residual value is what remains after subtracting all costs from the expected GDV.
When would you use the profits method of valuation?
The profits method of valuation is used when valuing properties where the value is closely tied to the business operating from the premises. It is typically applied in cases where no direct comparable evidence is available, such as:
- Trade-related Properties: For properties like pubs, hotels, care homes, and leisure facilities where the value is based on the business’s trading potential.
- Specialist Properties: Where the property’s value is intrinsically linked to the profits generated by the business using it.
The method calculates value based on the business’s gross income, minus operating expenses, to determine the net operating profit, which is then capitalised to give the property’s value.
In your experience you have undertaken Market Rent and Market Valuations - what are the bases of value as defined in the Red Book?
- Market Value (MV): The estimated amount a property should exchange for on the valuation date between a willing buyer and seller, after proper marketing, assuming each party acts knowledgeably, prudently, and without compulsion.
- Market Rent (MR): The estimated rent a property would command between a willing lessor and lessee on the valuation date under an arm’s length transaction, assuming the property is let in the open market at agreed terms.
- Fair Value (FV): Typically used in financial reporting, it represents the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
- Investment Value (Worth): The value of a property to a specific investor based on individual investment requirements and objectives.
- Existing Use Value (EUV): The value of the property assuming it continues to be used for its current purpose, without any alteration or redevelopment.
Each basis of value is used in specific contexts depending on the purpose of the valuation.
When would you use Fair Value?
Fair Value is typically used in financial reporting and is required under International Financial Reporting Standards (IFRS) and UK GAAP. It is applied in situations such as:
- Accounting Purposes: For financial statements, where assets and liabilities need to be reported at their fair value to give a true and fair view of a company’s financial position.
- Mergers and Acquisitions: To assess the value of assets and liabilities in the context of a business combination.
- Disputes or Litigation: To determine the fair value of assets when resolving disputes over ownership or compensation.
- Investment Portfolios: To establish the value of assets in investment funds where assets are frequently traded and must reflect current market conditions.
Fair Value reflects the price agreed upon by knowledgeable, willing parties in an orderly transaction, considering market conditions.
When you are undertaking a Red Book Investment Valuation, what sort of statutory due diligence would you carry out?
- Planning Status: Verify current planning permissions and any restrictions or conditions associated with the property’s use or development.
- Building Regulations: Ensure the property complies with building regulations, including fire safety, structural integrity, and any recent alterations or refurbishments.
- Environmental Searches: Check for any environmental issues, such as contamination or flood risk, that could affect the property’s value or future use.
- Legal Title and Tenure: Confirm the legal ownership, title, and tenure (freehold, leasehold) and review any encumbrances or rights of way that could impact value.
- Compliance with Statutory Requirements: Ensure the property complies with health and safety legislation, energy performance requirements (EPC), and other relevant statutory obligations.
- Zoning and Land Use: Verify the local zoning and land use regulations that could impact the property’s current or future potential.
Conducting these checks ensures that the valuation reflects any legal or regulatory factors affecting the property.
Turning to the example you have given in Manchester, the retail warehouse, you used the investment method - what was the purpose of the valuation?
Financial Reporting - For inclusion in financial statements under IFRS, where the Fair Value of the investment property must be disclosed
What might you request from the client to sign before you undertake the valuation?
- Terms of Engagement (Instruction Letter): This formal agreement outlines the scope of the valuation, the purpose, the basis of value, fees, and any assumptions or limitations. It ensures both parties are clear on the terms of the instruction and that the valuation complies with the RICS Red Book standards.
- Conflict of Interest Declaration: To confirm that there are no conflicts of interest between the valuer and the client or any other parties involved, ensuring an impartial valuation process.
- Confidentiality Agreement: If applicable, to ensure that any sensitive information provided by the client remains confidential and is used solely for the purpose of the valuation.
- Authority to Proceed: A formal confirmation from the client giving the valuer permission to commence work, particularly where third-party data (e.g., legal or planning documents) needs to be sourced.
These documents protect both the valuer and the client by clearly defining the terms of the valuation instruction.
What should be included in the ToE for a Red Book valuation?
- Identification of the Client: Clearly state who the client is, including any third parties who may rely on the valuation.
- Purpose of the Valuation: Define the reason for the valuation, such as for secured lending, purchase, financial reporting, or tax purposes.
- Property Details: Provide a description of the property, including location, size, and any relevant characteristics.
- Basis of Value: Specify the basis of value to be adopted, such as Market Value, Fair Value, or Market Rent, as defined by the RICS Red Book.
- Assumptions and Special Assumptions: List any assumptions or special assumptions that will be applied, such as vacant possession, planning status, or that the property is in good repair.
- Scope of the Inspection: Detail the extent of the inspection, including what will be examined on-site and any limitations to access or visibility.
- Date of Valuation: Specify the effective valuation date, which could be the date of inspection or another agreed-upon date.
- Fees and Expenses: Set out the valuation fee structure and any additional costs, such as third-party reports or travel expenses.
- Compliance with the Red Book: Confirm that the valuation will be undertaken in accordance with the RICS Valuation – Global Standards (the Red Book).
- Liability and Reliance: Define the extent of the valuer’s liability and who is entitled to rely on the valuation report.
- Conflicts of Interest: Include a statement about the valuer’s independence and any conflicts of interest (or the lack thereof).
- Confidentiality: State the confidentiality terms regarding the use of the valuation report.
- Disclosures: List any disclosures required by the Red Book, such as the valuer’s qualifications and experience, regulatory compliance, and previous involvement with the property.
- Timescale: Provide an estimated timeframe for completion of the valuation and delivery of the report.
- PI Insurance
- CHP
These components ensure the valuation is conducted professionally and in line with the client’s requirements and RICS standards.
Were there any assumptions in this case?
- Market Rent Assumption: It is assumed that the rent will be based on the open market value, reflecting current market conditions, comparable properties, and local demand at the time of renewal.
- Full Repairing and Insuring Lease (FRI): It may be assumed that the lease is on full repairing and insuring terms, where the tenant is responsible for the property’s repair and maintenance, as well as insurance.
- Tenant Covenant Strength: The tenant is assumed to have a reasonable financial standing, ensuring they can meet the lease obligations without significant risk.
- No Major Defects: It is assumed that there are no hidden structural defects or major maintenance issues that would affect the property’s rental value.
- Statutory Compliance: The property is assumed to comply with all statutory requirements, including planning, building regulations, and health and safety laws.
- Lease Terms: It may be assumed that the terms of the new lease will be the same or similar to the existing lease, unless specific changes are negotiated, such as rent review clauses or break options.
What is an example of a special assumption?
Assuming the property is in a state of good repair — even if, at the time of the valuation, the property is in disrepair.
This special assumption might be made if the lease contains a full repairing obligation, meaning the tenant is responsible for maintaining the property. The valuer would assess the rent as if the property were in the condition required by the lease, regardless of its current state.
Another example could be:
Assuming vacant possession at the end of the lease term, even if the current tenant is in place, to determine the market rent that could be achieved on the open market.
How did you arrive at your Valuation using the Term and Reversion method?
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The Term:
- This refers to the current rent being received under the existing lease. To value the term, I capitalise the current rent for the remaining duration of the lease at a yield that reflects the risk of that income stream.
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The Reversion:
- This represents the potential future rent once the lease expires, assuming the property will revert to its market rent. I calculate the future rent and then discount it back to present value using a reversionary yield to reflect the time until the reversion occurs.
Finally, the total valuation is the sum of the term value and the discounted reversion value.
What yield did you apply to the term? What yield for the reversion?
For the Term, I applied a 6% yield as the current income is secure, with an existing tenant in place and rent being received.
For the Reversion, I applied a 7% yield to account for the higher risk associated with the future income, reflecting uncertainty around securing a new tenant or market conditions at the lease expiry.
This approach captures the different risk levels between the current rent and the future potential rent.
Your residual valuation in Kidderminster - give me a broad outline of the residual valuation that you undertook
- Gross Development Value (GDV): First, I estimated the potential sale income from the completed development, which forms the Gross Development Value.
- Development Costs: I then calculated all the costs associated with the development, including construction costs, professional fees, finance costs, and contingency allowances.
- Profit Margin: I factored in a developer’s profit, which is typically expressed as a percentage of the GDV or total development costs, to ensure the project is financially viable.
- Residual Land Value: Finally, I subtracted the total development costs (including the profit margin) from the GDV to arrive at the residual land value. This represents the amount a developer could pay for the land while still making an acceptable return on the project.
What did those development costs include?
- Construction Costs: The costs of building the development, including materials, labour, and any associated infrastructure.
- Professional Fees: Fees for architects, surveyors, engineers, and other consultants involved in the project.
- Planning and Legal Fees: Costs related to obtaining planning permission and any legal fees associated with the development.
- Finance Costs: Interest on any loans or financing used to fund the development during the construction phase.
- Contingency: A contingency allowance, typically around 5-10% of construction costs, to cover unforeseen expenses or changes in the project.
- Marketing and Disposal Costs: Costs associated with marketing the completed units and selling them, including agent fees and legal costs.
- Developer’s Profit: A profit margin, typically expressed as a percentage of the Gross Development Value (GDV), which reflects the return required by the developer.
What were the build costs (psf/psm)? Where did you get that information from?
£143 per sq. ft (inclusive of locational weighting)
From BCIS
What finance rate did you apply?
I applied a finance rate of 7.5%.
This reflects the cost of borrowing for the development, including interest on loans and any associated financing fees. The rate was based on prevailing market conditions and typical lending terms for development projects at the time.
Would a 6% finance rate still be applicable today in a residual valuation?
Given current market conditions, a 7.5% finance rate may no longer be appropriate. With interest rates and borrowing costs rising, especially due to inflation and central bank policies, finance rates for development projects have generally increased. Today, I would expect to apply a higher finance rate, potentially in the range of 8%, depending on the specific market and project risk profile.
It’s essential to adjust the finance rate to reflect current economic conditions and the availability of credit.
What would you do when carrying out inspections for valuations?
I would have regard to VPS 2 which states that all inspections and investigations must be carried out to the extent which is needed to produce the valuation which is professionally adequate for its purposes.
