VALUATION Flashcards
In terms of valuation, do you know what the red book is?
The Red book contains mandatory rules, best practice and guidance for valuations for members of the RICS. The latest edition came into affect, 31st January 2022.
What documents does the Red book cover?
RICS Global standards, international valuation standards, RICS national supplement
Can you tell me some key sections of the Red Book?
Introduction, mandatory valuation standards, advisory valuations standards
What are the recent changes to the red book?
Implementation of Valuation Review recommendations
Alignment with development in other relevant global standards and regulations such as the new IVS
Adaption to evolving practices and processes for issues ESG and technological advancements
When will the changes to the Red Book Global Standards become effective?
31 January 2025
What are the basis’s of value under the red book?
Market value, market rent, investment value, fair value
What is market 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 arms length transaction after proper marketing and where the parties had each acted knowledgeably, 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 and where the parties had each acted knowledgeably, prudently and without compulsion.
What is investment value?
The value of an asset to the owner or a prospective owner for individual investment or operational objectives.
Investment value is an estimate of value of a property to a particular owner or purchaser who may wish to analyse the potential performance against certain investment criteria, for example, a target rate of return, as opposed to those prevailing in the market. Often used in conjunction with DCF
What is fair value?
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.
What is synergistic value?
Not defined in VPS 4. defined in IVS 2022.
The result of combination of two or more assets or interests where the combined value is more than the sum of the separate values. If the synergies are only available to one specific buyer, then synergistic value will differ from market value, as the synergetic value will reflect particular attributes of an asse that are only of value to a specific purchaser. The added value above the aggregate of the respective interests is often referred to as marriage value.
Could you tell me what the 5 methods of valuation are?
Comparable, depreciated replacement cost, residual, profits, investment
Can you talk me through the comparable method of valuation?
Look at the attributes of the subject property, search and select comparables based on factors of comparability, confirm and verify details and analyse, assemble the comparables in a schedule, adjust them using the hierarchy of evidence, analyse them to form an opinion of value, report value.
Is there any guidance to follow when considering comparable evidence?
RICS Guidance Note, Comparable evidence in real estate valuation, 1st edition 2019
This outlines the principles in the use of comparable evidence.
How many categories are there in the hierarchy of comparable evidence?
3– A to C
What are Category A comparables?
Direct comparables:
Completed transaction of near identical properties for which full and accurate information is available, this may include data from the subject property itself
Completed transactions of similar real estate for which full data may not be available, but for which enough reliable data can be obtained to use as evidence
Similar real estate being marketed where offers may have been made but a binding contract has not been completed
Asking prices (only with careful analysis)
What are category B comparables?
General market data that can provide guidance:
Information from published sources or commercial databases; its relative importance will depend on relevance, authority and verifiability
Other indirect evidence (e.g. indices)
Historic evidence
Demand/supply data for rent, owner occupation or investment
What are category C comparables?
Other sources:
Transactional evidence from other real estate types and locations
Other background data e.g. interest rates, stock market movements and returns which can give an indication for real estate yields
How did you find relevant comparables?
Inspection of an area to find recent market activity by seeking agents boards
Visit/speak to local agents
Auction results (these are gross prices) – take care as can be special purchaser or insolvency sale
In house records/databases and websites such as EGI
Market sentiment when lack of transactional evidence
Date of evidence is crucial
What is the hierarchy of rental evidence?
New Letting, Lease renewal, rent review (market rent basis), independent expert, opinion, arbitration, asking rents
Can you talk me through the depreciated replacement cost method?
Establish replacement cost – modern equivalent
Adjust replacement cost for age and obsolescence
Add in any site value
= cap value
Depreciate at statutory decapitalisation rate for rating
= annual equivalent/ trental value
What is obsolescence?
The process of becoming outdated and no longer used.
What are the different types of obsolescence?
Physical obsolescence is the result of deterioration/wear and tear over the years
Functional obsolescence is where the design or specification of the asset no longer fulfils the function for what it was originally designed
Economic obsolescence is due to changing market conditions for the use of the asset
Can you talk me though the residual method?
Aim is to establish how much a purchaser should pay for a site. Establish GDV and deduct all costs associated with undertaking the development. Deduct profit and this leave residual land value
What costs would you deduct in residual?
Site prep, construction, sales, marketing, contingency, financing fees
Can you talk me through the profits method?
Annual turnover (income received)
Less costs/purchases
= gross profit
Less reasonable working expenses
=unadjusted net profit
Less operator remuneration
= adjusted net profit know as Fair Maintainable Operating Profit
Capitalise at an appropriate yield (YP) to achieve market value
Cross check with comparable evidence if possible
Can you talk me through the investment method?
Rental income capitalised to produce a capital value.
Conventional method is rent received x YP = market value
How would you carry out your investment method if the property was under rented?
Using the term and reversion method. Term capitalised until the next review/ lease expiry at an initial yield. Reversion to market rent valued in perpetuity at a reversionary yield.
How would you carry out your investment method if the property was over rented?
Layer/hardcore method where income flow is divided horizontally. Bottom slice = market rent. Top slice = rent passing less market rent until lease event. Higher yield applied to top slice to reflect additional risk. different yields used depending on comparable investment evidence and relative risk.
How do you choose what yield to apply?
Based on comparable evidence
Risk is a major factor when determining yields but other factors are prospects for rental and capital growth, quality of location and covenant, use of the property, lease terms, obsolescence, voids, security and regularity of income, liquidity
Can you tell me some average yields in the current market?
Current yields as at Jan 2024 ; offices 4/5%, high street retail 7%, industrial 5-6%
What does it mean if a yield is all growth implicit?
Risks hidden in selected yield
On the comparable method, can you outline key factors that you would look at to see if it is comparable?
Physical similarity – age, condition, size
Use – same use, planning use class can offer some guidance on same use
Location – same location
Transaction date – closer to valuation date the more comparable transaction
Market conditions – interest rates
Quality and reliability of the source of evidence – details of the transaction
Type of transaction and sale conditions – lease terms
Amount of adjustment required – more adjustment, less reliable
Why would you use one method over another?
Lack of similar properties so depends on the type of property you are looking at
How would you value a property if it was under rented?
Term and reversion
When does the red book not apply?
Red book does not apply to estimated replacement cost figures for insurance purposes.
What is included in terms of engagement?
Identification and status of the valuer, confirmation of the client and any other users of the report to be produced, property to be valued including any tenancies, purpose of valuation, basis of value, valuation date, special assumptions, assumptions and the extent of investigations and any limitations on the scope of work.
How does residual valuation work? What are the steps/inputs?
Stage 1 – assess the best scheme of development for the land
Stage 2 – assess the value of the assumed development on completion,
Stage 3 – assess all the costs of completing the assumed development scheme.
Stage 4 – estimate residual land value
Gross development value less development costs and desired profit = capital value
What are the benefits and drawbacks of the comparable method?
Drawbacks could be limited transaction data, lack of up to date evidence, existence of a special purchaser, lack of similar evidence, limited market transparency
How would you value if there were no comparables?
Contractors method
Difference between assumptions and special assumptions
Assumption is where it is reasonable to accept that something is true without the need for specific investigation or verification.
Special assumption is where an assumption either assumes facts that differ from those existing or that would not be made by a typical market participant
Definition of market value and where would you find this definition
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 arms length transaction after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion. Defined at VPS 4.
Definition of special purchaser and where would you find this definition
A particular buyer for whom a particular asset has a special value because of advantages arising from its ownership that would not be available to other buyers in a market. Found in the glossary of the Red Book
What valuations are not red book?
There are no exemptions from compliance with PS 1-2 when providing valuation advice. However, there are circumstances where VPS 1-5 may be unsuitable or inappropriate to comply with: Statutory basis, negotiation or litigation, internal purposes, agency, expert witness valuation
What is included within the terms of engagement?
Identification of any other intended users
Identification of the asset being valued
Valuation currency
Purpose
Basis of value
Valuation date
Nature and extent of work
Nature and source of information relied upon
Assumptions and special assumptions
Restrictions on use, distribution and publication
Bases on which fee is calculated
Where are the terms of engagement within the red book?
VPS1
What is an internal valuer?
Employed by company to value internal assets, no third party reliance
What is an external valuer?
Has no material links with the asset to be valued
What are the three steps to undertake prior to commencing with a valuation instruction?
Competence, Independence, Terms of Engagement
Why is due diligence undertaken?
To check there are no material matters, which could impact upon the valuation
What are some statutory due diligence checks?
Business rates, contamination, EPC, Flooding, Legal title and tenure
What are the six steps when undertaking the comparative method?
Search, verify, schedule, hierarchy, analyse, report
When would you use the investment method of valuation?
When there is an income stream to value
What is a yield?
A measurement of investment return. Expressed as a percentage of capital invested.
How do you calculate a yield?
Income/ price x 100
How do you calculate Years purchase?
100/ yield
What is years purchase?
Number of years required for its income to repay its purchase price
What are some key risks that should be considered when arriving at yield?
Quality of covenant, lease terms, voids, security, use of property, market sentiment
What is an all risks yield?
Yield which reflects all the prospects and risks attached to a particular investment
What is a true yield?
Assumes rent is paid in advance, not in arrears
What is a nominal yield?
Assumes rent is paid in arrears
What is a gross yield?
not adjusted for purchasers costs
What is a net yield?
adjusted for purchasers costs
What is an equivalent yield?
average weighted yield when 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 current price on an investment let at a rent below the market value
What is a running yield?
the yield at one moment in time
What does your choice of investment method depend on?
Whether the rent is equal to market rent, under rented or overrented.
How do you convert from gross to net?
Deduct purchasers costs
What is included in purchasers costs?
SDLT, agent and legal fees
When would you undertake a term and reversion?
When the property is under rented
How yield impacts value?
If increase annual rent, yield increases
If increase yield, capital value decreases
If increase capital value, yield decreases
Why do we carry out conflict of interest checks?
Because as per the RICS rules of conduct valuers are to act with integrity. As part of this we need to identify actual and potential conflicts and not provide services where this is the case unless we do so in accordance with the current edition of Conflicts of Interest.
What is the current edition of conflicts of interest?
Effective 1 Jan 2018
How did you carry out a conflict of interest check?
Check for party, own interest or confidential information conflicts. Looking at previous work carried out. Do I have any personal connection with the property or client. Are we acting for another client
What is a red book valuation?
A formal opinion of value which can be relied upon by an instructing party. Signed off by someone who is part of the registered valuer scheme.
Where are the standards for red book valuations?
Red Book Global Standards
Do all valuations have to comply with the red book?
There is no circumstances where written valuation advice is completely exempt from the red book. Departure for the following circumstances only:
1. Providing agency o brokerage service in respect of the acquisition or disposal of one or more assets
2. Acting or preparing to act as an expert witness
3. Performing statutory functions
4. Valuation purely for internal purposes, without liability, and without communication to a third party.
Which parts of the red book are mandatory?
PS1-2 VPS1-5
What is a title plan?
Show a boundary of an area of land in a registered estate.
Why are terms of engagement issued?
Outline the conditions of the valuation. They also help to define the circumstance and context in which complaints can be made or managed.
When is term and reversion applied
When the rent is below market value
What is a development appraisal?
A financial appraisal of a development. Typically output is development profit although other output metrics can be used.
Please explain you understanding of the rotation rules for valuation contained within the RICS Red Book UK Supplement?
The RICS released an updated UK supplement of the Red Book in January 2022 to update its recommendations around mandatory rotation cycles for regulated valuations. The new rules mean that firms undertaking valuations for regulation purposes will not be able to repeat this service for more than 10 consecutive years. This will require a change or rotation to an alternative valuation firm with the aim of improving transparency and serving the public interest. The new regulations took effect May 2024 with the RICS providing a series of briefings to help the industry understand this new requirement.
Please explain you understanding of the RICS Discounted Cash Flow Valuations Guidance Note November 2023?
This guidance note has looked to provide further clarity around the difference between the Market Value and Investment Value definitions set out under RICS VPS 4. Investment value is defined as the valuation of property that is applicable to a specific investor as opposed to Market Value that is applicable to the wider market as a whole. The guidance note calls for the use of market based inputs when making an assessment of market value using the Discounted Cash Flow method rather than inputs that relate to Investment Value.
What are the different purposes of valuation?
Valuation for financial reporting
Commercial secured lending purposes
Capital gains, IHT, SDLT
