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%
