Valuation Flashcards
What steps should be taken before commencing a valuation instruction?
- Competence - Ensure I have the correct level of Skills, Understanding, and Knowledge (SUK).
- Independence - Check for any conflicts of interest and personal interests.
- Terms of Engagement -Set out in writing full instructions and receive written confirmation of the instruction.
What are some statutory due diligence for valuations?
- Asbestos register
- Business rates
- EPC rating
- Flooding
- Contamination
- Legal title and tenure
- Highways
- Planning history
- Public rights of way
- H&S and Fire Safety compliance
- Environmental matters (power lines, sub-stations telecoms masts)
What are the 5 methods of valuation?
- Comparative method
- Investment method
- Profits method
- Residual method
- Contractors method (Depreciated Replacement Cost)
What is the comparative method of valuation?
Search & select comparables, verify details and analyse headline rent to give a net effective rent. Assemble comparable schedule, adjust comparables using the hierarchy of evidence, and analyse to form opinion of value.
Valuers should use professional judgement to assess the relative importance of evidence on a case by case basis.
Hierarchy of Evidence:
Category A - Direct comparables of near identical properties / subject property completed transactions of similar property, similar properties being marketed (with offers - careful when considering quoting rents)
Category B - General market data, historic comparables, commercial databases etc.
Category C - Other sources such as background data (interest rates), other locations etc.
What is the investment method of valuation?
Used when there is an income stream to value - the rental income is capitalised to produce a capital value.
Conventional method assumes growth implicit valuation approach. An implied growth rate is derived from the market yield.
Conventional Investment Method:
Rent received / Market Rent multiplied by the years purchase equals the market value (importance on rent & yield).
Term & Reversion:
Used for reversionary investments (under-rented). Term is capitalised until next lease event at an initial yield. Reversion to Mart Rent valued into perpetuity at a reversionary yield.
Hardcore & Layer:
Traditionally used for over-rented investments. Income is divided horizontally. Bottom slice = Market Rent | Top Slice = Rent passing less Market Rent until next lease event. Higher yield applied to the top slice to reflect additional risk. Different yields used depending on comparable investment evidence and relative risk.
What is the Equivalent Yield approach?
It is an Investment Valuation technique for reversionary investments (growth implicit) where a valuer applies an equivalent yield to the entire income stream, to determine value. It is often easier to try to justify applying two different yield inputs to the income stream, particularly when a risk premium applied to the reversionary income stream is hard to explain from market evidence. It reduces the valuation variables by determining an overall yield for the investment - the weighted average yield combing in the initial and reversionary yields.
What is a yield and how is it calculated?
A yield is a measure of investment return, expressed as a percentage of capital invested.
Calculated by income divided by the price multiplied by 100.
A Years Purchase is calculated by dividing 100 by the yield. This is the number of years required for its income to repay its purchase price.
Risk is the major factor when determining a yield - it concerns:
- Prospects of rental /capital growth
- Quality of location and covenant
- Lease terms
- Obsolescence
- Security and regularity of income.
What is a net and gross yield?
Gross Yield - The yield not adjusted for purchasers costs (e.g., an auction result)
Net Yield - The resulting yield adjusted for purchasers costs
What is an equivalent yield?
Average weighted yield when a reversionary property is valued using an initial and reversionary yield.
What is an initial yield?
Simple income yield for current income and current price.
What is a reversionary yield?
Market Rent divided by the current price of an investment let at a rent below the market rent.
What is an All Risks Yield?
The remunerative rate of interest used in the valuation of fully let property let at market rent reflecting all the prospects and risks attached to the particular investment.
What is the Discounted Cash Flow (DCF) valuation technique?
A growth implicit investment method of valuation - DCF determines the value of a property by examining its future net income or projected cash flow from the property and then discounting the cash flow to arrive at an estimated current value of the property. The approach separates out and explicitly identifies growth assumptions rather than incorporating them within an ARY.
It is used for valuations where the projected cash flows are explicitly estimated over a finite period e.g., short leasehold interests / properties with income voids or complex tenures, phased development projects, social housing etc.
Methodology:
1. Estimate the cash flow (income less expenditure)
2. Estimate the exit value at the end of the holding period.
3. Select the discount rate.
4. Discount cash flow at discount rate.
5. Value is the sum of the completed discounted cash flow to provide the Net Present Value (NPV).
What is the Profits Method of Valuation?
Used for valuations of trade-related property where there is a monopoly position e.g., pubs, petrol stations, hotels, care homes etc. Used where the value of the property depends upon the profitibaility of its business and its trading potential.
Must have accurate audited accounts for 3 years (if possible).
Methodology:
Annual turnover (income received) less costs / purchases
= Gross profit
Less reasonable working expenses
= Unadjusted net profit
Less operators remuneration
= Adjusted net profit known as Fair Maintainable Operating Profit (FMOP) - can be expressed as EBITDA.
Capitalised at an appropriate yield to achieve Market Value (cross-checked with comparables if possible).
What is the Residual Method of Valuation and a Development Appraisal?
A Development Appraisal is a tool to financially assess the viability of a development scheme, assess the profitability of a proposed scheme and its sensitivity to changing inputs, or assessing the viability of different uses / rents / yields etc.
The Residual Method of Valuation can be used to establish a residual site value.
Development Appraisals can assume a site value or calculate a site value. Residual site valuations can find the market value of the site based on market inputs.
Methodology for a Residual Site Valuation:
1. Establish Gross Development Value (GDV) - the market value of the completed proposed development. Use the comparable method to establish rents / All Risk Yield
LESS
- Establish the Total Development Costs (TDC) which is made up of:
- Planning costs (planning application, building regulation fees, planning consultant fees, specialist reports etc.)
- Building costs (from BCIS / building surveyor etc.)
- Professional Fees - 10-15% plus VAT of total construction costs (architects, M&E, consultants, project managers, structural engineers etc)
Contingency - 5-10% of construction costs depending on risks
- Marketing costs & fees - 1-2% GDV and normal letting fee around 10% of initial annual rent.
- Finance costs - assumed 100% debt finance - interest can include the current SONIA, Base Rate, rate the developer can borrow money.
- Developers profit - 15-20% of GDV or total construction costs.
Consider:
1. Development Finance - debt finance or equity finance. LTV typically 60%, senior debt prioritised, mezzanine funding is additional funding over the normal LTV
2. Overage - sharing of any extra receipts received over an above the profits originally expected.
3. Profits Erosion Period - the length of time it takes for the development profit to be eroded by holding charges following the completion of the scheme until the profit from the scheme has been drawn down from e.g., interest charges.
4. Sensitivity Analysis - Simple Sensitivity analysis (varying yields / GDV / build costs), Scenario Analysis (changing timings, e.g., scheme phasing), Monte Carlo Simulation (using probability theory).
What is the Depreciated Replacement Costs (DRC) Method of Valuation?
Also known as the Contractors Method - Method of last resort. Should only be used where direct evidence is limited or unavailable for specialised properties e.g., sewage works, lighthouses, oil refineries, schools etc.
Used for owner-occupied property, for accounts purposes and for rating valuations for specialised properties.
Methodology:
1. Value of land in its existing use (assume planning permission exists)
2. Add current cost of replacing the building plus fees less a discount for depreciation and obsolescence / deterioration.
Obsolescence can be physical, functional (design/spec no longer fulfils function), or economical (changing market conditions).
When would you not be required to use the Red Book Global for valuations?
Valuations have to be Red Book Global compliant except for:
- Advice expressly provided for negotiations or litigation.
- The valuer is performing a statutory function (except in a statutory return to a tax authority).
- Valuation is provided for internal purposes.
- Valuation is provided for agency or brokerage work (except when a purchase report is required which includes a valuation)
- Valuation advice provided in anticipation of giving evidence as an expert witness.
What is included in the Terms of Engagement?
Minimum requirements confirmed in writing to the client prior to commencing a Red Book Global valuation, include:
- Identity & status of valuer
- Identity of client
- Asset to be valued
- Currency
- Purpose of valuation
- Basis of value
- Valuation date
- Fee basis Assumptions and special assumptions
- Complaints handling procedure to be made available.
- Format of the report.
- Assumptions and Special Assumptions
- Confirmation of Red Book Global / IVS Compliance
- Extent of Investigations
What are Assumptions and what are Special Assumptions and where in the Red Book can you find guidance on them?
RICS Valuation - Global Standards (“Red Book Global”) 2021 - VPS 4: Bases of Value, assumptions, and special assumptions (part 8 & 9).
Assumptions are made where it is reasonable for the valuer to accept that something is true without the need for specific investigation.
Special Assumptions are suppositions that are taken to be true and accepted as fact, even though they are not true.
What are the minimum requirements to be stated within a Red Book Global compliant valuation report?
VPS 3 Valuation Reports (IVS 103 Reporting) - Requirements include:
- Identity & status of valuer
- Client / other intended users
- Purpose of valuation
- Identity of asset being valued
- Basis of valuation
- Valuation date.
- Extent of investigation.
- Nature and source of info relied upon.
- Assumptions and Special Assumptions
- Valuation approach and reasoning
- Valuation figure(s)
- Comment on market uncertainty
- Statement setting out any limitations on liability that have ben agreed.
What is Market Value?
The estimated amount for which an asset or liability should exchange:
- On the valuation date
- Between a willing buyer and willing seller
- In an arms length transaction
- After proper marketing
- Where parties had acted knowledgably, prudently, and without compulsion
What is Market Rent?
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 arms length transaction
- After proper marketing
- Where the parties have acted knowledgably, prudently and without compulsion.
What is Fair Value?
Fair Value - IFRS 13
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.
- Basis now required if IFRS have been adopted.
- RICS view is that this definition is generally consistent with the definition of Market Value.
What is Investment Value?
The value of an asset to a particular owner, or prospective owner for the individual investment or operational objectives
- It may differ from Market Value
- Sometimes used as a measure of worth to reflect the value against a the clients own investment criteria.
How may a conflict of interest arise in secured lending valuations?
Previous (within 2 years) / current / anticipated involvement with the prospective borrower or property must be disclosed to the lender.
- Having a longstanding professional relationship with the prospective borrower/owner
- When the valuer will gain a fee from introducing the transaction to the lender.
- If there is financial interest in the property or prospective borrower.
- When the valuer is a retained to act in the disposal or letting of the completed development on the subject property.
What are some things that must be reported in a Secured Lending Valuation?
As well as the minimum requirements of a valuation report, there is additional information that must be reported, including:
- Disclosure of any involvement identified in the terms of engagement.
- The Valuation methodology adopted.
- Comment on environmental consideration.
- Any circumstances of which the valuer is aware that could affect the price
- Comment on the suitability of the property for mortgage purposes.
What are the current valuation monitoring requirements?
UK VPS 3 Regulated Purpose Valuations (RICS Valuation Monitoring)
These are valuations relied on by 3rd parties who have not commissioned the valuation and they are subject to valuation monitoring:
- Financial reporting (company accounts)
- Stock Exchange listings
- Takeovers and mergers
- Collective investment schemes
- Unregulated property unit trusts.
(Secured lending valuations are not regulated purpose valuations as they aren’t relied upon by 3rd parties)
Monitoring Requirements:
- Annual declaration for all members now in place to declare the length of time valuer has acted for the client for regulated valuation purposes/ extent / duration of firms relationship
- In last financial year, if % fee income from the client is less or more than 5% of total fee income
- Policy on the rotation of valuers when the asset is regularly valued.
What is the permissible margin of error in respect of valuations?
The margin of error can be varied - it will be narrower for a relatively straightforward valuation case and wider for a more complex case.
There may be a +/-5% for a standard residential property, but for a one-off commercial property +/-10% and if there are exceptional features of the property, the margin could be +/-15%.
What is Hope Value?
The value arising from any expectation that future circumstances affecting the property may change.
For Example:
1. Future prospect of securing planning permission for the development of land.
2. Realisation of marriage value arising from the merger of two interests in land.
What is Marriage Value?
Created by the merger of interests (physical or tenurial).
Undertake a before and after valuation and calculate the level of marriage value created.
What is Stamp Duty Land Tax (SDLT) in England and how is it charged?
The current rate of tax for non-resi or mixed use property payable by the purchaser in respect of the transfer of land and buildings:
£0-£150,000 = Nil
£150,001-£250,000 = 2%
Over £250,000 = 5%
For residential property:
£0-£250,000 = Nil
£250,001-£925,000 = 5%
£925,001-£1,500,000 = 10%
Over £1,500,000 = 12%
- SDLT is charged on an incremental basis at different rates depending on the portion of the purchase price that falls into each band.
- April-16 higher rates of SLDT charged on purchases of additional resi properties (second homes) at 3% above the current SDLT rate.
- First time buyers claim relief with a nil rate up to £425,000 and 5% on the portion from £425,001 to £625,000. No relief over £625,000.
- Scotland has SLBTT and Wales has WLTT.
- The Annual Tax on Enveloped Dwellings (ATED) provisions aims to stop on shire and off shore individuals using companies to avoid SDLT for resi property. Current threshold = £500,000.
SDLT is payable on the grant of new leases and premiums payable, calculated on the Net Present Value of the lease (total rent payable over the term reduced by an annualised discount rate), discounted at the RPI as an incremental tax:
NPV up to £150,000 (£125,000 for resi) = Zero
NPV of over £150,000 (£125,000 for resi) = 1%
NPV over £5,000,000 = 2%
How are Charities valued?
The Charities Act 2011 requires trustees of a charity to obtain a valuation prior to the disposal of an asset in accordance with Section 19.
The report must confirm the charity has obtained the best terms for the transaction.
What is a Special Buyer and Special Value?
Red Book Global defines a Special Buyer as ‘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.’
Special Value is the amount that reflects particular attributes of an asset that are only of value to a Special Buyer.
Examples - tenant purchasing their freehold interest.
What are building cost reinstatement valuations?
For building insurance purposes, it is the cost of the reinstatement of the building without profit.
Use of BCIS adopting a GIA for commercial properties and GEA for resi. Add VAT, demolition costs, professional fees, planning and building regulation fees and inflation allowance if applicable.
Provided for insurance purposes, it is not a ‘written opinion of value’ so Red Book Global compliance is not required.
How are long leasehold interests valued?
The ground rent is deducted from the gross income to calculate the net rent received. This is capitalised at a yield for the length of the lease to create a market value.
DCF can also be used.
Leasehold interests can be viewed as wasting assets - dual rate tables adjust a leasehold valuation to be on the same basis as a freehold by using a sinking fund. However, in practice leaseholders don’t use sinking funds so current valuation practice often uses a single yield rate, duly discounted to reflect an additional element of risk for the wasting asset.
What are Premiums?
Premiums are capital payments made by one party to another.
They can arise in many instances:
- Key money paid by an ingoing tenant of a retail property to secure a prime shop.
- Sum of money paid by a landlord to a tenant for the surrender of a leasehold interest and the grant of a new lease.
- Sum of money to represent fixtures and fittings within a building, paid by an ingoing tenant.
What are Purchasers’ Costs?
Usual valuation practice to deduct the likely costs of purchase from the gross market value to provide a net market value of a property as a purchaser would have to pay these.
Assumed:
1. SDLT - at the prevailing rate.
2. Agents Fees - 1% of the purchase price plus VAT.
3. Solicitors Fees - 0.5% of the purchase price plus VAT.
What is a WAULT?
Weighted Average Unexpired Lease Term remaining to the first break or expiry of the lease across asset weighted by the contracted rent.
Calculation often undertaken when valuing an asset or considering an appropriate investment yield.
It is calculated by multiplying the current rent by the remaining lease term (in years) of each tenant. Divide the sum of all the tenants by the total annual income of the property.
How would you analyse rent-free periods / headline rents?
I would devalue a headline rent with a rent-free period to produce a net effective rent (the real market rent).
Straight line basis either until the end of the lease or until the next review / lease event.
Normally a 3-month fitting out period is deducted from the rent-free period before devaluation.
3 Methods:
1. Straight line method
2. Straight line method assuming time value of cash flow using a yield.
3. Use a DCF.
What is a ransom strip and how is it valued?
It is a piece of land which controls the access to another piece of land.
The Upper Tribunal evidence suggests that the value of a ransom strip could be 15% to 50% of the development value unlocked by the inclusion of the ransom strip within the proposed scheme.
In some cases a fixed sum has been awarded.
The Upper Tribunal assesses each case on its own facts.
What is Zoning?
A valuation technique used for the comparison of retail properties to create a unit of comparison for different sized buildings.
Rationale - the rental value of the property reduces away from the street.
The halving back principle with 6.1m (20ft) zones. (9.14m or 30ft zones are used in some prime London, Belfast and Scottish retail streets).
Basements / first floor areas are usually treated as A/10 approx., depending on comps.
Return frontages usually adds 10% uplift, depending on comps / footfall.
What are Party Walls?
A wall is a ‘Party Wall’ if it stands astride the boundary of land belonging to two or more different land owners.
Specialist Chartered Surveyors deal with these disputes - The Party Wall etc Act 1996 provides a framework for resolving these disputes.
If you are a party wall owner, you must inform all adjoining owners of your intention to undertake any works to the party wall.
What are Rights to Light?
The right to light of a building arises after 20 years uninterrupted enjoyment of light without consent of a third party by way of an easement with a prescriptive right.
If a right to light is infringed, an injunction can be granted, or damages awarded.
What is the RICS Valuer Registration Scheme (VRS) and how do you register?
A regulatory monitoring scheme for all valuers carrying out Red Book Global valuations.
Aims:
1. Improve quality of valuations and ensure highest professional standards.
2. Meet the RICS’ requirement to self-regulate.
3. Protect and raise the status of the valuation profession as the leading expertise in valuation.
Registration is not mandatory for the valuation work excluded from the Red Book.
To register, info is required on the valuation work undertaken:
- Type of valuations
- Purpose of valuations
- Number of valuations
- Firm’s total fee income from Red Book valuations
- Data sources used
- Quality assurance audit procedures in place
- History of any negligence claims and notifications
What is the structure of the RICS Valuation - Global Standards 2021 (Red Book Global), Effective 2022?
The Red Book Global includes:
- Professional Standards:
- PS 1 - Compliance with Standards and Practice Statements where a written valuation is provided.
- PS 2 - Ethics, Competency, Objectivity, and Disclosures. - Valuation Technical and Performance Standards (VPS):
- VPS 1 - Terms of Engagement.
- VPS 2 - Inspections, Investigations, and Records
- VPS 3 - Valuation Reports
- VPS 4 - Basis of Value, Assumptions and Special Assumptions
- VPS 5 - Valuation Approaches and Methods - Valuation Applications (Valuation Practice Guidance Applications - VPGAs):
- VPGA 1 - Valuation for Inclusion in Financial Statements
- VPGA 2 - Valuation of Interests for Secured Lending
- VPGA 3 - Valuation of Businesses and Business Interests
- VPGA 4 - Valuation of Individual Trade Related Properties
- VPGA 5 - Valuation of Plant and Equipment
- VPGA 6 - Valuation of Intangible Assets
- VPGA 7 - Valuation of Personal Property, Including Arts and Antiques
- VPGA 8 - Valuation of Real Property Interests
- VPGA 9 - Identification of Portfolios, Collections and Groups of Properties
- VPGA 10 - Matters that may give rise to material Valuation Uncertainty - International Valuation Standards (IVS)
What are the approximate prime and secondary yields across the different asset classes?
Based on Knight Frank data in March 2024:
- Offices: Prime = 4%-5% | Secondary = Circa 11%
- Warehouse & Industrial: Prime = 5%-5.50% | Secondary = 6%-7%
- High Street Retail: Prime = 3% (Bond St) - 7% (prime towns) | Secondary = 7.25% (Regional Cities) - 10% (Good Secondary)
- Out of Town Retail: Prime = 6% | Secondary = 8%
- Leisure: Prime = 8% | Secondary = 9%
What are the standard regards and disregards for rent reviews?
Regards:
1. Available to let on the open market between a willing tenant and a willing Landlord for a term of years as stated.
2. Property is fit and available for immediate occupation and use.
3. All covenants observed by landlord and tenant.
4. Property may be used for purpose set out in the lease.
Disregards:
1. Any effect of goodwill on tenants occupation
2. Ignore goodwill attached to the property.
3. Tenants improvements if landlord consent has been granted for the works.
When might a property not be suitable for secured lending purposes?
Property’s may not be suitable for lending purposes under certain circumstances, dependent on the lenders own criteria, such as:
- Non-conventional Construction - if there is evidence of non-traditional construction methods (as opposed to standard construction) in a property, lenders may decline a mortgage (unusual building techniques / materials can raise concerns)
- Sub-standard walls - properties with features like single-skin brickwork or sub-standard walls may deter lenders.
- Uninhabitable Condition - if the property is not considered habitable by the lenders standards.
- Physical or legal risks - properties with significant physical or legal risks may be deemed not lendable. For example, environmental matters like contamination or Japanese Knotweed.
Can you explain your understanding of the rotation rules for valuations contained within the RICS Red Book UK Supplement?
- The RICS released an updated UK supplement of the Red Book in Jan 2022 to update its recommendations around mandatory rotation cycles for regulated valuations.
- New rules mean firms undertaking valuations for regulation purposes will not be able to repeat this service for more than ten consecutive years.
- Requires a change or rotation to an alternative valuation firm with the aim of improving transparency and serving the public interest.
- New regulations will take effect on 1st May 2024 with the RICS providing a series of briefings to help the industry understand this new requirement.
Can you explain your understanding of the RICS Discounted Cash Flow Valuations Guidance Note November 2023?
Guidance Note provides clarity around the difference between the Market Value and Investment Value definitions set out under RICS VPS 4.
Investment Value = the valuation of property that is applicable to a specific investor.
Market Value = Valuation of property that is applicable to the wider market as a whole.
Guidance Note calls for the use of market based inputs when making an assessment of Market Value using the DCF method rather than inputs that relate to Investment Value.
What current market conditions would you highlight when providing Development Appraisal advice to a client?
I would highlight the importance of considering current rising interest rates and high levels of inflation that result in:
- Rising borrowing costs depending on the financing model being adopted - could mean a lower level of return.
- Falling demand for commercial office space following Covid-19 and a shift towards home working could result in a lower rental income, longer voids, and reduction in GDV.
- Recent pull back of borrowing products from specialist lenders who are withdrawing competitive borrowing rates and being more more sensitive.
- High levels of inflation and a strong demand for specialist labour and building products has resulted in building costs remaining high resulting in increased build costs and lower levels of return for developers.
What is your view of the IPMS Updates?
I think IPMS when established globally will provide an extremely useful set of measurement standards that will hopefully negate ambiguity across international markets.
In reality, it is proving very difficult to achieve due to the existing preferences in place in each market place.
For example, the UK has been slow to adopt the IPMS due to a familiarity and preference of the existing standards.
I am also awaiting the updated RICS Professional Statement for Property Measurement to find out how the Institution and experts within the profession view the updated IPMS.
Are there any recent changes to the RICS Valuation - Global Standards 2021 (“Red Book”)?
The key changes to the updated Red Book relate to:
- Need for compliance with the Red Book Global and adequate Terms of Reference to reflect this (PS 1 and VPS 1) - Terms of Reference must be clear and unambiguous in that valuations are either RBG compliant or not.
- Valuation for financial reporting purposes (VPGA 1) - Reference to IFRS 13 and 16 and the need to provide reasonably possible fair value measurements.
- Reference to the use of the profits method for certain trade related property valuation (VPGA 4) - a non-exhaustive list of properties includes self-storage, flexible workspace and purpose-built student housing.
- Sustainability and ESG factors:
- Definitions of ESG and Sustainability in respect of assets
- Inspection and reporting (VPS 2 & 3) - valuers should have regard to to the relevance of ESG and sustainability factors which forms part of the valuation methodology, including commentary
- Valuation for secured lending (VPGA 2) noting ESG and sustainability factors, plus commentary on maintainability of income, and future cost liabilities.
- Direct and indirect valuation reference, and physical and transition risks (VPGA 8)
What parts of the RICS Valuation - Global Standards 2021 (“Red Book Global”) are mandatory, and which are discretionary?
Part 3: RICS Professional Standards (PS) are mandatory worldwide.
Part 4: Valuation Technical & Performance Standards (VPS) are mandatory worldwide.
Part 5: Valuation Applications (Valuation Practice Guidance Applications - VPGAs) are advisory
Part 6: The International Valuation Standards (IVS) are adopted and applied through the RICS Red Book Global Standards, being cross reference throughout parts 3-5.
How do the International Valuation Standards differ from the RICS Valuation - Global Standards (“Red Book Global”)?
The IVS consist of mandatory requirements that must be followed in order to state that a valuation was performed in compliance with the IVS.
The International Valuation Standards Council (IVSC) is an independent not-for-profit organisation committed to advancing quality in the valuation profession. Their primary objective is to build confidence and public trust in valuation by producing standard securing their universal adoption and implementation for the valuation of assets across the world.
How reliable is a quoting rent when determining Market Rent?
Quoting rents should be considered in conjunction with recent direct transactional evidence.
Quoting rents do not reflect completed transactions, and can be higher than the market rental level, as they do not represent the rent achieved between a willing lessor and lessee exchange on the open market etc.
However, quoting rents provide an indicative level of where the market is at, and can be valuable evidence.
Northampton - Retail Warehouse example:
What are the key drivers of value for a retail warehouse? What did you note on inspection?
A key driver of valuation for retail is location and accessibility. Proximity to major roads, highways, transport hubs, and its visibility / ease of access attracts tenants and customers which enhance value.
Other drivers include physical condition & quality, tenant quality (covenant strength) and lease terms, market trends and supply, permitted uses etc.
On inspection, I noted the location / aspect, tenants in the vicinity, condition & quality of the unit, specification, vacant units etc.
Can you undertake a Red Book valuation without inspecting?
Yes, I am aware that Desktop Valuations can be undertaken, which is reliant on available data, market trends, and comparable evidence. It is essential to acknowledge the limitations and potential risks associated with not physically inspecting.
Equally, Red Book compliant valuations can occur when the property has previously been inspected valued.
Northampton - Retail Warehouse example:
You said that you paid most regard to a recently let adjacent unit of comparable size. What adjustments did you make to reflect this comparable?
When arriving at my opinion of Market Rent, I considered:
- Date of letting
- Size
- Location and aspect
- Configuration & Layout
- Specification
- Condition
- Lease terms
Northampton - Retail Warehouse example:
You considered the unit to be over-rented so adopted the hardcore and layer technique.
Can you talk through how you valued this?
As I considered the unit to be over-rented, I divided the income stream horizontally, applying a higher yield to the top slice which is the rent passing less the market rent until the next lease event. This is to reflect the greater risks involved.
I capitalised the bottom slice at a keener yield as this reflected the Market Rent which attracts less risks.
Different yields are used depending on comparable investment evidence and relative risk.
Northampton - Retail Warehouse example:
How did you determine the different yields that you adopted for the hardcore and layer technique? How did you determine the difference / risk differential?
To arrive at my adopted yields, I considered comparable investment transactions in the vicinity, and compared the subject property against these transactions to analyse the tenants covenant strength, WAULT, condition & specification of the unit, location & situation, date of sale, and use.
Dividing the income stream horizontally, I adopted a softer yield to the over-rented layer until the next lease event to reflect the greater risk, and capitalised my opinion of rent at a harder yield into perpetuity.
High Wycombe - Industrial example:
You valued an owner-occupied property - who was the client?
I valued an owner-occupied industrial unit for loan security purposes, meaning the Lender / Bank was my client as they instructed Colliers to value the property to establish it suitability for loan security.
High Wycombe - Industrial example:
You said that you investigated the EPC, flood risk, and site density amongst other things. Why is this important and what relevance did it have on your advice?
I am aware that EPCs are required for all commercial buildings (with certain exceptions) when it is newly built, sold, or let for a term of more than 6 months and less than 99 years. It is also important to consider the EPC rating, and how it aligns with current MEES Regulations.
Reporting on flooding risk is also important as there is a focus on sustainability reporting in Red Book valuations. It is a requirement to report on environmental matters such as flooding for Secured Lending valuations.
With regards to Site Density, this is important to establish as it will drive the adopted valuation methodology. If the yard is particularly large, I may have considered looking at this area in isolation and applying a yard rate to the surplus area.
These due diligence factors are an important part of the valuation as they can dictate the adopted valuation methodology and have a significant impact on the reported value.
High Wycombe - Industrial example:
You analysed vacant possession evidence using the comparable method to arrive at you opinion of Market Value. What would you have done if there was no comparable evidence?
If there was no or very limited vacant possession comparable evidence, I would have considered having primary regard to the hypothetical investment method.
I would have assumed a hypothetical term and capitalised an appropriate yield at my opinion of market rent, included a void period at the start, and allowing for vacant rates in line with current legislation.
I would have underpinned this valuation methodology using the comparable method, if there were some VP comps which I considered were comparable.
High Wycombe - Industrial example:
In your hypothetical investment calculation, you assumed a 5-year term certain. Why was this, and why didn’t you assume e.g., 15 years, and what impact does this have on your reported value?
Through my due diligence and market searches, I established through comparable evidence that most occupiers would agree to a 5-year term certain (i.e. this could be 10 year with a break in year 5) in the current market. I did not consider a straight 15 year term would be achievable or reflective of current market conditions.
I recognise that if the property had a longer term certain, this may enhance the market value as it reduces risk, provides stability through a longer secured income stream, and improves the investment confidence.
Why does a Lender want an opinion of Market Rent?
A Lender wants to understand the associated risks with the property in order to make informed decisions and assess the property’s suitability for loan security.
Understanding the market rent helps a lender evaluate the property’s income potential, stability of rental income, and aids the understanding of disposal considerations.
High Wycombe - Industrial example:
In your hypothetical investment valuation calculations, you allowed for vacant rates in accordance with current legislation. What do you mean by this?
By vacant rates, I refer to the Rates Liability which I calculate from the Rateable Value of the property, and apply a multiplier based on current legislation to the RV to arrive at the Rates Liability.
The Landlord is responsible for paying the vacant rates, therefore I made an allowance for this in my calculations.
High Wycombe - Industrial Example
Why did the client request a Special Assumption on a Restricted Marketing Period of 6 months?
Lenders may want to know want to assess the property’s value under adverse conditions as a risk assessment consideration, such as if the property had to be sold quickly.
There are also practical considerations as some clients may need to make decisions promptly, especially in distressed situations.
High Wycombe - Industrial Example:
When reporting the MV on the special assumption of a restricted marketing period of 6 months, you deducted approximately 10%.
- Why did you deduct 10%, and why is it approximate?
- If the client was not happy with a 10% discount, what systems are in place to deal with a complaint / negligence?
- Did you consider the margin of error with this, and if so, what is the permissible margin of error?
- From undertaking market research and collating comparable evidence, I established that a suitable timeframe to dispose of the property would be 9-12 months. From speaking with investment agents and colleagues, I considered a 10% deduction is market practice for restricted marketing periods of 6 months, and that this would be reasonably adopted for High Wycombe.
I deducted approximately 10% as the Market Value was rounded to a whole number, therefore it was not exactly 10%. - If the client was not happy with the assumptions, I would discuss this with them with clear and effective communications to explain the valuation methodology and assumptions. However, if they issued a formal written complaint, this would trigger my firm’s Complaints Handling Procedure.
- I am aware that there is case law surrounding the permissible margin of error for valuations - Singer & Friedlander Ltd vs JD Wood (1977).
The margin of error can be varied, and will be narrower for more straightforward valuation cases, and wider for more complex cases. This principle is a +/-5% margin for residential properties, +/-10% margin for commercial properties, and +/-15% for commercial properties with exceptional features.
Your valuation examples include two industrial units in the South East, a retail warehouse unit in the midlands, and an office in the south east.
What are prime yields in these locations?
Industrial South East: Prime Yield - 5.25%
Retail Warehouse - Open A1 Parks = 6%
Office South East: Prime Yield = 7.25%
Swanley - Industrial example:
You said that you undertook prior due diligence which included assessing the Environrisk Wizard Report issued by the client concerning the land and ground conditions.
What observations did you make?
Was there anything that would impact the valuation?
Could a property with contamination be suitable for loan security?
On review of the Environrisk Wizard Report, the dataset identified potentially contaminative land uses on the site including the presence of waste management facility formerly on the site. I recognised that such industrial activities may present a potential source of contamination to the underlying soils and / or groundwater and may impact the property’s value.
Whilst I advised that further works / investigations are required, I considered that the property was located in an established commercial area, and so was of the opinion that more potential purchasers would consider the ground condition to be suitable for it’s current use, and would not require environmental testing to be carried out. However I did not provide any warranty in this regard.
I also advised that if the site is subsequently developed for more sensitive uses, such as residential, then it may be necessary to undertake a more detailed investigation.
In reaching my opinion of Market Value, I did not make any allowances for any effect in respect of actual or potential contamination, and assumed that any environmental matter that exist in relation to the Property are not sufficient to affect its value.
Swanley - Industrial example:
You mentioned that you measured the unit on a GIA basis. What else could you have measured?
I could have measured the site using a trundle wheel whilst on site. Alternatively, I could have used online platforms like Promap or Edozo
Swanley - Industrial example:
You adopted a split yield valuation approach. Can you talk me through how you did this.
I analysed the covenant strength and term certain of each tenant. As one of the tenants had a weaker covenant strength and very short term certain, I applied a softer / higher yield to reflect the greater risk involved.
I capitalised the income of the tenant with a stronger covenant strength and longer term certain at a harder / keener / lower yield to reflect the less risks associated with that income stream.
Aside from adjusting a yield to reflect the risk of an investment, how else can you reflect risk in a valuation?
From my experience, adjusting a yield to account for the risks associated with the property is the most common method - it considers comparable evidence and can be justified.
I am aware that a sensitivity analysis can be used for development and residual appraisals which can be based on probability (monte Carlo), scenarios (e.g., phase developments), or a simple variables (GDV, costs, finance rate etc).
If I were to adopt the Discounted Cash Flow valuation technique, I could account for risk by adopting a higher discount rate, which affects the present value of the future cash flows.
Swanley - Industrial example:
You mentioned that you created a SWOT analysis and advised an opportunity would be to renew the leases upon expiry to maintain occupancy and rental levels.
How would a renewed lease impact the valuation?
If the property had a longer term certain, this may enhance the market value as it extends the secured rental income, reduces the risks associated with the property, provides stability, and improves investment confidence / marketability.
How do you determine if a property is suitable for loan security? What would make a property not suitable for loan security and how would you communicate to your client that it was unsuitable?
To determine if a property is suitable for loan security, in the valuation report I create a SWOT analysis which sets out strengths, weaknesses, opportunities, and threats associated with the property. I will also report on environmental matters and anything which may impact value, marketability etc.
A property may not be suitable for loan security if it is uninhabitable, if there are environmental concerns (e.g., contamination, Japanese Knotweed etc), or if the property does not meet the lending criteria of the bank.
If I considered the property was not suitable for loan security, I would ensure it is clearly set out in the report, along with reasoning. I am aware that it is down to bank to make the decision, where they will use my knowledge of the market and property to reach a verdict. I would discuss this with the client and ensure communication is clear and informative.
What is a Liability Cap?
A Liability Cap in valuations is a mechanism used to limit the potential financial exposure of a valuer or surveyor, specifically when when a valuer has conducted a valuation negligently.
Its primary purpose is to manage risks in valuation work, and helps to protect businesses and limits the amount that a client or third party can request in the event of a claim.
Appropriate wording under Liability Cap might be - We confirm we hold appropriate PII for this instruction in accordance with the Service Agreement.
Other forms it could be drawn upon:
- Liability capped at 30% of the Market Value
- Liability Capped at 100% of the loan in accordance with the ToE.
- Liability capped at lesser or £2m or 20 x fee and so explicitly £200,000, in accordance with the ToE.
What is the Loan to Value Ratio?
The LTV is an assessment of lending risk that financial institutions and other lenders examine before approving a mortgage.
Typically, loan assessments with high LTV ratios are considered higher-risk loans. Therefore, if the mortgage is approved. the loan has a higher interest rate.
Do you know any case law in valuation?
Margin of Error:
The leading case concerning margin of error is Singer & Friedlander Ltd vs J.D. Wood (1977) where it was held that the usual margin of error can be varied, and it will be narrower for a relatively straightforward valuation case and wider for a more complex case.
Right to Light:
The landmark case is HKRUK II (CHC) Ltd (a subsidiary of Highcross) vs Heaney (2011). The outcome let Highcross with a remedial works bill and a mandatory injunction to reduce the scale of its extended Toronto Square scheme in Leeds where two new floors were added to an existing office building.
The Right to Light of a building arises after 20 years uninterrupted enjoyment of light without the consent of a third party by way of an easement with a prescriptive right.
