Valuation

Question 1

What is the RICS Red Book?

Answer 1

The RICS Red Book is a set of Global Standards for valuation, incorporating the IVSC International Valuation Standards issued November 2024, effective from 31 January 2025.

First published in 1976, the Red Book is recognized globally as a rigorous reference for valuation standards.

Question 2

What are the key updates in the recent RICS Red Book?

Answer 2

The recent changes include:
* Alignment with new international valuation standards
* Addition of context relating to modelling and method
* Adaptation to changes from technology and ESG.

Question 3

What are key principles emphasized in the RICS Red Book?

Answer 3

Key principles include:
* Transparency
* Consistency
* Avoidance of conflicts of interest.

Question 4

What are mandatory professional standards in the RICS Red Book?

Answer 4

Mandatory professional standards include:
* PS 1 – compliance with standards for written valuations
* PS 2 – ethics, competency, objectivity, and disclosures.

Question 5

What does VPS stand for and what is its purpose?

Answer 5

VPS stands for Valuation Technical and Performance Standards, which are mandatory and relate to the implementation of guidance to ensure IVS (International Valuation Standards) compliance.

Question 6

What is VPS 1 focused on?

Answer 6

VPS 1 focuses on terms of engagement, including the scope of work, identification of responsible valuer, clients, assets, and valuation details.

Question 7

What is VPS 2?

Answer 7

Bases of value, assumptions, and special assumptions. The valuer must ensure the basis of value adopted is appropriate for and consistent with the purpose of the valuation.

Question 8

What are the difference bases of value under VPS 2?

Answer 8

Market Value
Market Rent
Investment Value
Equitable Value
Synergistic Value
Liquidation Value
Fair Value

Question 9

What is the difference between Market Value and Fair Value?

Answer 9

Fair Value is used for financial reporting and does not include costs.

If using an income approach, the capitalisation of the net rent using a comparable net discount rate will produce a capital value figure that represents the total outlay of the purchaser, including costs. So, a deduction has to be made from this figure to estimate market value/fair value to allow for a typical buyer’s costs – otherwise the value will be overstated.

Question 10

Define Market Value as per VPS 2.

Answer 10

Market Value is defined as the amount an asset should exchange between a willing buyer and seller in an arm’s length transaction after proper marketing.

It assumes parties are knowledgeable, prudent, and not under compulsion.

Question 11

What is included in VPS 3?

Answer 11

Valuation approaches and methods. The three main valuation approaches are:
* The Market Approach (based on comparing subject to similar assets)
* The Income Approach (based on capitalisation or conversion or present and predicted income to produce a single currently capital value)
* The Cost Approach (purchaser will pay no more than the cost to obtain one of equal utility)

Question 12

What does VPS 4 include?

Answer 12

Inspections, investigations and records. Valuers should inspect and investigate and keep good clear records to maintain a proper audit trail

Question 13

What is the purpose of VPS 5?

Answer 13

Valuation models used. They must be checked for errors

Question 14

What is the purpose of VPS 6?

Answer 14

VPS 6 is a critical and defining feature of the red book. It relates to valuation reports, stating they must clearly and accurately set out conclusions as to not be ambiguous or misleading. Must address matters in the TOE and significant ESG factors

Question 15

What is VPGA?

Answer 15

VPGA refers to RICS Global Valuation Practice Guidance Applications that provide guidance for valuations for specific purposes and for specific asset types. They are best practice and not mandatory

Question 16

List three types of VPGA.

Answer 16

Types of VPGA include:
* VPGA 1 – Valuations for financial reporting
* VPGA 2 – Valuations for secured lending
* VPGA 3 – Valuations of businesses and business interests.
* VPGA 11 – Relationship with auditors

Question 17

What are UK VPGA?

Answer 17

A UK supplement setting out specific requirements and guidance for members on the application of the RICS Valuation Global Standards (Red Book Global Standards) to valuations undertaken subject to UK jurisdiction.

Question 18

What UK VPGA’s should I be aware of?

Answer 18

UK VPGA 4 Valuation of local authority assets for accounting purposes
UK VPGA 4.3 Operational property, plant and equipment. Existing use value should be adopted using the DRC method.
UK VPGA 17 – Local authority disposal of land for less than best consideration

Question 19

What are the 5 methods of valuation?

Answer 19

Comparable Method
Investment Method (income)
Residual Method
Profits Method
DRC Method (Depreciated Replacement Cost)

Question 20

What is the Comparable method of valuation?

Answer 20

The Comparable method is the most widespread, used to assess market rent and value based on a good body of recent reliable comparable rental or sales evidence.

Question 21

Which RICS professional standard relates specifically to the comparable method of valuation?

Answer 21

Comparable evidence in real estate valuation 1st edition (2019)

Question 22

What is a hierarchy of evidence?

Answer 22

It should be be considered to ensure that appropriate weighting is applied based on the type of transaction. Open Market Lettings rank higher than lease renewals.

Question 23

What is the Investment method used for?

Answer 23

The Investment method is used where there is an income stream to value.

Question 24

What is the process of valuing a property using the investment method?

Answer 24

You need to be able to assess rental values (market rent) and market-based yields.
You should be able to reflect income streams which are under-, rack- and over-rented by incorporating risk within the yield choice (i.e. an all risks yield) and by structuring the calculation appropriately. This will require the valuer to reflect risk in each element of the calculation.

Question 25

What is the term and reversion approach?

Answer 25

It is used when a property has an existing lease in place that is due to expire. The existing lease terms are considered sperate from the expected new lease terms within the valuation approach. In this instance the property is assume to have reversionary potential taking into account the new lease terms

Question 26

What is the hardcore and top slice or layer approach?

Answer 26

It onsiders the current market rent being received and applies this on a perpetual basis. The difference between the current rent being received and expected market rent at the time of the lease renewal is also considered on a perpetual basis. The two separate values are then added within the calculation.

Question 27

When would you use a term and reversion vs a hardcore and topslice?

Answer 27

If the property is underrated it would be better to use the term and reversion, and if the property is overrented, it would be best to use hardcore and top slice. You would increase the yield above the market in the topslice to reflect the added risk of an above market rent being paid for a specified period, or reducing the yield in the term to reflect that a below market rent is being paid until the reversion is due.

Question 28

What is a yield?

Answer 28

A yield can be simply defined as the annual return on investment expressed as a percentage of capital value. (annual rent/property value*100)

Question 29

What type of yield is included within the traditional investment methods of valuation?

Answer 29

The yield is growth implicit, meaning rental growth is built into the choice of yield and not explicitly modelled within the calculation.

Question 30

What is a DCF?

Answer 30

A discounted cash flow, where the yield is growth explicit. The cashflow is explicitly modelled incorporating a wide range of valuer-inputted assumptions. Typically the rate of return used in a DCF will reflect a risk-free rate plus a property risk premium. If a DCF is based on client data rather than market data, then it will represent investment value rather than market value.

Question 31

When would you use a DCF?

Answer 31

When there are no comparable market transactions or where there is expected short term market volatility present, for example if the tenant is due to terminate their lease. Additionally, it can be applied if multiple investment are being compared side by side to support long term investment decisions. Estimated cash flows are projected over an assumed investment period in addition to an exit value at the end of an investment period. The case flow is then discounted back to the present day value at the discount rate (desired rate of return) that reflects the perceived level of risk. The discount rate is applied to reflect market and property specific risks. Void costs need to be considered. The exit valuation needs to reflect the rental growth and unexpired terms of the leases at the exit date. Assumptions and forecasts must be clearly set out

Question 32

What does the Residual method assess?

Answer 32

The Residual method is used for properties with development potential, calculating the market value of land after deducting development costs. To apply the residual method, you need to first assess the development potential of the land, i.e. highest value use. They then need to calculate the value of the finished scheme, i.e. gross development value (GDV) based on market comparables. All development costs are then deducted from GDV, including developer’s profit and finance costs

Question 33

Define the Profits method.

Answer 33

The Profits method is used for specialist income-producing properties, such as hotels, golf courses, car parks. Their value will depend on business profitability, trading potential, and 'goodwill'.

Question 34

What is the process followed in the profits method?

Answer 34

It involves establishing fair maintainable operating profit (FMOP) capable of being generated by a reasonably efficient operator (REO). This is based upon assessment and analysis of fair maintainable turnover (FMT), requiring sound knowledge of accounting principles and market norms for the specific industry sector. A market-based profit multiplier is then used to convert FMT into a capital value

Question 35

What is the Depreciated Replacement Cost (DRC) method?

Answer 35

The DRC method is used for owner-occupied or specialised properties rarely sold on the open market. It is also known as the method of last resort and should not be used where there are market sales of comparable properties. It could be used as a check valuation against another method. The basic steps involved include assessing the cost to replace the land and the building (with a modern equivalent, including all associated costs) before making appropriate deductions for depreciation and obsolescence. It is based on the assumption the market will pay no more for the existing property than the amount it would cost to buy an equivalent site, plus the cost of constructing an equivalent building.

Question 36

What does the equivalent yield represent?

Answer 36

The equivalent yield is the weighted average of the net yield from current income and future reversionary income.

Question 37

What is the equated yield?

Answer 37

The yield on a property investment which takes into account growth in future income. This is not applicable to reversionary situations when the increase in income on reversion is to the market value as estimate at the present time

Question 38

List factors that affect yields

Answer 38

* Covenant * Location * Specification * Rent levels * Growth potential * Asset management and development value

Question 39

What is the importance of having PII and run off cover in valuation?

Answer 39

To protect against claims made by clients for losses incurred due to negligent valuations. Merrett v Babb