Valuation Flashcards
What are the first steps you should take at the start of any valuation?
1) Competence (SUK)
2) Conflict of Interest
3) Terms of Engagement
What are some examples of Statutory Due Diligence necessary for any valuation?
Statutry Due Diligence checks can include:
Asbestos Register
Business Rates
Contamination
Equality Act (2010) compliance
Environmental Matters (High voltage power lines, telecoms masts etc)
EPC Rating
Flooding Risk (check Environmental Agency)
Health & Safety compliance
Fire Safety compliance
Legal title and tenure (check the boundaries / ownership, Land Registry).
Planning History (e.g. check if conservation area / Listed)
Why are statutory due diligence checks carried out in valuation?
To check there are no material matters which could impact on the value
What are the 3 Valuation Approaches?
(IVS 105)
- Income Approach (converting cash flow into capital value, i.e the investment method, residual method and profits method)
- Cost Approach (reference to the cost of the asset, i.e. Depreciated Replacement Cost method).
- Market Approach (Using comparable evidence, i.e. Comparative method)
IVS = International valuation Standards (Jan 2024). The Redbook full incorporates the IVS.
What are the 5 methods of Valuation?
Redbook
(COMMON QUESTION)
- Comparative Method.
- Investment Method.
- Profits Method.
- Residual Method.
- Depreciated Replacement Cost (DRC).
Please describe how you would use the Comparative Method to value a property?
(COMMON QUESTION)
V IMPORTANT ONE
With reference to the RICS Professional Standard: “Comparable Evidence in Real Estate Valuation” (2019).
Methodology - SIX steps:
- Search and select Comparables.
- VERIFY details and analyse to get a Net Effective Rent.
- Create schedule of Comparables.
- Adjust comps in relation to the Hierarchy of Evidence.
- Analyse to form opinion of value (MR / MV).
- Report value & prepare file note. Stand back & look.
When using the comparative method, is there any specific guidance you adhere to?
(What is the RICS Guidance for comparable method)
RICS Professional Standard: Comparable Evidence in Real Estate Valuation (2019). This was republished as a Professional Standard in 2023.
It specifically outlines the Hierarchy of Evidence.
What is the Hierarchy of Evidence in Comparable Valuation?
(COMMON QUESTION)
Think about difference to L&T.
Framework for comparables based on weighting:
Category A = DIRECT COMPARABLES
- Data from the subject property itself (the best)
- Completed transactions of near-identical properties
- Contemporary, full and accurate information
- Asking prices (only with careful analysis)
Category B = GENERAL MARKET DATA
- Published sources / Commercial Databases (e.g. CoStar). Importance will depend on verification.
- Historic evidence
- Supply / Demand data (Rent, Owner occupation or investment).
Category C = OTHER SOURCES
- Wider market data (interest rates, stocks & shares).
- Transactional evidence from other real estate types and locations.
What makes a good comparable?
Huge focus on “Contemporary” in the Hierarchy of Evidence (“Contemporary, full and accurate information”).
The best comparable will be an almost identical property, next door to the subject property which transacted yesterday and you have full information on the deal. Think:
- Contemporary (recent)
- Location
- Similarity
- Transparency
- Arms-length, open market transaction
How would you find comparable evidence?
Inspection of the local area to find ‘TO LET’ boards
Speaking with local agents
CoStar / property databases and VERIFY the information
What would you do when there is a lack of comparable evidence?
(This is a good question)
Have to rely on** older data** and ‘quoting’ prices.
Also look down the Hierarchy of Evidence and consider Category B / C evidence such as supply and demand data.
Always consider market sentiment at the time when there is a lack of comparable evidence.
You could also look at using an alternative valuation method which is less reliant on comparable evidence.
Also consider VPGA 10 “Matters that give rise to Material Uncertainty”.
VPGA * Valuation Practice Guidance - Applications.*
When would you use the Investment Method?
When there is an income stream to value.
The rental income is ‘capitalised’ to produce a capital value.
What are the different types of Investment Method?
Conventional Investment Method (Rack-Rented)
Term & Reversion (Under Rented)
Hardcore Layer (Over Rented) - Core and topslice
Outline the basics of the conventional investment method?
The rental income is capitalised to produce a capital value
Growth Implicit valuation approach - growth is derived from the yield. Often the “All Risks Yield”
Used when a property is rack-rented.
When would you use the Term & Reversion method?
Used for reversionary investments (under-rented) i.e. when the properties passing rent is below the market rent.
The ‘Term’ (passing rent) is capitalised until the next lease event at an initial yield.
The ‘Reversion’ to market rent is capitalised into perpetuity at a reversionary yield.
When would you use the Hardcore Layer method?
When the property is over-rented, i.e. passing rent is more than the market rent.
I would divide the income stream horizontally.
Bottom Slice = Market Rent.
Top Slice = Passing Rent - Market Rent until next lease event.
Higher yield applied to the top slice to reflect additional risk. Yield derived from comparable evidence.
If you had a rack-rented property, how would you value it?
The rental income is capitalised (by a yield) to produce a capital value.
Establishing the yield would then allow me to capitalise the rental income by the Years Purchase (YP).
For properties that are rack-rented
What is a Yield?
Reflects a return on an investment, expressed as a percentage (%).
(remember the higher the yield, the riskier the asset is perceived to be).
How would you calculate a yield?
Two ways to establish a yield:
1) Rental Income / Property Price x 100
2) Comparable evidence. Use Central London Yield Guides to cross check.
What is the difference between the YP and the Yield?
Years purchase.
YP is the inverse ratio of the yield.
YP = (1 / Yield).
Years Purchase (YP), single rate or the Present Value (PV) of £1 per annum receivable at the end of each year after accounting for a sinking fund to accumulate at the same rate of interest
What are typical Prime Rents and Prime Yields in central London for:
1) Offices
2) Retail
3) Industrial
TO BE CONFIRMED
Offices:
Prime Yield (West End) = 3.5%
Prime Yield (City) = 4%
Prime Headline Rent (West End) = £125 per sq ft
Prime Headline Rent (City) = £82.50 per sq ft
Yield for retail = 6% (high street)
Yield for industrial = 3.5% - 4% (although have softened recently).
What is an ‘All-Risks’ Yield?
Yield which encompasses all the risks, uncertainties and prospects of an investment.
Used on a fully let property at market rent.
(Growth + Risk implicit)
What is an Initial Yield?
The simple income yield for current income and current price.
It will be the rental income / price x 100.
What is a Reversionary Yield?
Used when under-rented.
It is the market rent / current price on an investment that’s under rented.
What is an Equivalent Yield?
The weighted average yield between the initial and the reversionary yield.
When would you use the DCF technique?
Growth Explicit
Valuations where the projected cash flows are explicitly estimated over an assumed investment holding period.
E.g.
- Short leasehold interests and properties with income voids or complex tenures.
- Phased developments projects
- Non-standard investments (e.g. 21 year rent reviews).
-This method separates out and explicitly identifies growth assumptions rather than incorporating them in an all risks yield.
Describe how you would calculate investment value using the DCF technique?
Involves projecting estimated cash flows over a finite period.
- Estimate cash flow for duration (break down income - all expenditure)
- Estimate exit value (at end of holding period)
- Select discount rate
- Discount cash flow
- Sum of the DCF is NPV.
You’re discounting back to the present day at a discount rate (aka IRR to reflect levels of risk).
What is the Net Present Value (NPV)?
The sum of the DCF.
It shows if the investment will likely give a positive return at the investors target rate of return (IRR).
Positive NPV = The investment has exceeded the investor’s target rate of return.
Negative NPV = The investment has not achieved the target rate of return.
What is the Internal Rate of Return (IRR)?
An IRR is the discount rate at which the NPV of all income streams will equal zero.
Used to assess the total return from an investment.
What can a valuer use if they don’t have a software package to calculate the IRR?
How do you choose your discount rate?
Linear Interpolation
Find a discount rate that produces a negative and positive NPV, then interpolate between the two.
When would you use the Profits method?
Used for TRADE-RELATED property.
When the value of the property depends upon the PROFITABILITY of its business and trading potential.
E.g. pubs, hotels, petrol stations, leisure, care homes
How would you undertake a valuation using the Profits method?
CHECK THIS CARD
Basic principle is the value depends on PROFIT generated from the business (not the physical building).
- Get past 3 years’ audited accounts
- Adjusted net profit = Establish Fair Maintainable Operating Profit (FMOP) by deducting costs/expenses.
- EBITDA (Earnings Before Interest, Tax, Depreciation & Amortisation) capitalised at an appropriate yield to find Market Value.
Cross check with comparable sales evidence if possible.
- Capitalise at an appropriate yield to achieve market value.
What is the Residual method of valuation?
Used to establish the RESIDUAL LAND VALUE of a development opportunity.
Used to determine the Market Value (land price) of a development site based on market inputs.
This is a form of development appraisal.
How would you carry out the Residual method of valuation?
- Estimate the GROSS DEVELOPMENT VALUE (GDV) (the value of the completed development) using market assumptions (at the current date of valuation).
- Subtract Construction Costs (build costs)
- Subtract Developers profit ( and other costs: planning costs, professional fees)
Remainder = Residual Site Value.
(Cross check using the comparative method based on land sales).
*NB costs are often provided.
What are the limitations of the Residual Method?
- Reliant on accurate information / inputs (getting build costs in a volatile market)
- Highly sensitive - small adjustments can mean big change.
- Doesn’t consider the timing of payments.
- Assumptions are hidden and deals with finance in a basic manner.
What Guidance is available with regards to the Residual Method?
RICS GN ‘Valuation of Development Property’ (2019)
- Cross check other land sales using comparative method
- Sensitivity Analysis
- DCF for complex schemes
What is the difference between a Development Appraisal and a Residual Valuation?
Development Appraisal: establish the viability/PROFITABILITY of a proposed development using a CLIENTS inputs.
Residual Valuation: establish the MARKET VALUE (residual land value) of a site using MARKET inputs.
What is the Depreciated Replacement Cost (DRC) used for?
DRC is used when a specialist, unique asset that does not produce an income is to be valued.
Used for ‘Owner-Occupied’ property rarely sold on the open market.
Should only be used when no comparable evidence & for specialised property - method of “last resort”.
E.g. Light House, Oil Rig, ancient monument, Hospitals, Power stations.
DRC used for a Dilapidated ancient monument / castle because it can’t be converted.
Why is the Depreciated Replacement Cost a method of last resort?
Because it assumes a correlation between cost and value (when there is not).
What is the methodology for using the Depreciated Replacement Cost (DRC)?
(2 points)
- Value the land (site value) in its existing use (assuming planning permission exists)
- Add current cost of replacing the building with a modern equivalent (estimated using BCIS). Then depreciate based on age and obsolescence (functional, technical and economic).
Using the DRC method you need to estimate the amount of depreciation appropriate for physical, functional and economic obsolescence - explain each.
PHYSICAL = Result of wear and tear/deterioration over the years.
FUNCTIONAL = Where design or specification no longer fulfils function it was originally designed for.
ECONOMIC = Changing market conditions for use of the asset.
What does the Red Book say about Depreciated Replacement Cost?
NOT suitable for secured lending purposes.
Used for specialised properties only for inclusion in their financial statements.
How do you calculate Net Effective Rent?
(COMMON QUESTION)
This is how you devalue a headline rent with a rent-free period to produce a Net Effective Rent.
I use the straight line basis in Excel until the next lease event.
To do this - aggregate the cost of all rental payments (to include rent-free period and any other incentives) and divide by the lease length.
I would deduct a 3-month fitting out period from the rent-free before devaluation (unless the space was ready fitted).
What incentives would you be looking at analyse in a Net Effective Rent?
Rent-free period
Premiums
Stepped rent
