Valuation Flashcards
What is the Red Book?
The red book outlines mandatory practices for RICS members conducting a valuation, ensuring consistency and adherence to high professional standards
What is the structure of the Red Book?
- Introduction
- Glossary
- Professional Standards
- Valuation technical and performance standards (VPS 1-6)
- Valuation practice guidance applications (VPGA 1-11)
- International Valuation Standards
When does a valuation have to be Red Book compliant?
Mandatory use for all valuations except for:
1. Providing an agency service in respect of the acquisition or disposal of one or more assets
2. Providing valuation advice expressly in preparation for, or during, negotiations or litigation
3. Acting or preparing to act as an expert witness
4. Performing statutory functions
5. Providing valuations to a client purely for internal purposes, that exclude the valuer’s liability and without communication to a third party
What are the two RICS Profssional Standards outlined in the Red Book?
PS1 - compliance with standards and practice statements where a written valuation is provided (5 exemptions)
PS 2 - ethics, competency, objectivity and disclosures
Outline what VPS 1 states?
Terms of engagement:
- Identification and status of the valuer
- Identification of the client
- The asset to be valued
- Currency
- Purpose of the valuation
- Basis of value
- Valuation date
- All assumptions and special assumptions to be made
- Confirmation that the valuation will be undertaken in accordance with RICS Red Book Global Standards
- Basis on which the fee will be calculated
- CHP
- Limitation on liability agreed
- Consideration of any ESG factors
Outline what VPS 2 states?
Bases of value, assumptions and special assumptions
What is the definition of 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 arm’s length transaction, after proper marketing, and where the parties have acted knowledgeably, prudently, and without compulsion
What is the definition of market rent?
The estimated amount for which an interest in real property should be leased on the valuation date between a willing lessor and willing lessee on appropriate lease terms, in an arm’s length transaction, after proper marketing, and where the parties act knowledgeably, prudently, and without compulsion
What is the definition of 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 the definition of investment value?
The value of an asset to its current or prospective owner, considering their individual investment or operational objectives
What does VPGA1 state?
Fair value must be adopted for valuations for accounts purposes
What does VPGA2 state?
- Any previous, current or anticipated involvement with the prospective borrower or the property to be valued must be disclosed to the lender
- ‘Previous involvement’ is defined as normally being within the past two years
- If the valuer or the client considers that any involvement creates a conflict that cannot be avoided, then the instruction should be declined
What does the new RICS Valuation Global Standards seek to introduce?
- Alignment with the new International Valuation Standards
- New content relating to valuation modelling
- Valuers must now record relevant ESG data & consider factors which might impact valuation
- The use of AI
What are the 5 methods of valuation?
- Comparative
- Investments
- Profits
- Residual
- Contractors (Depreciated Replacement Cost)
IVS 105 Valuation Approaches and Methods
What are the 3 approaches?
- Income approach (investment/residual/profit method)
- Cost approach (contractors method)
- Market approach (comparable method)
What is the comparative method of valuation?
- Gather comparables and confirm details
- Adjust headline rent to ‘net effective rent’ if appropriate
- Assemble in a schedule adjust using ‘Hierarchy of Evidence’
- Analyse to form an opinion of value and report the value
When is the investment method of valuation used?
- Use when there is an income stream, rental income is capitalised to produce a capital value
- Conventional method assumes growth implicit where implied growth rate is derived from the market capitalisation rate (yield)
When is term and reversion used?
Used for reversionary investments (market rent more than passing rent), term capitalised until next lease event at an initial yield, reversion to market rent valued in perp at a reversionary yield
When is layer/hardcore used?
Used for overrented investments, income flow horizontally split
Bottom slice = Market Rent into perp
Top slice = Passing rent less market rent unil next lease event
Higher yield applied to top slice to relfect additional risk
Can you talk me through the discounted cashflow technique?
- Growth explicit investment method of valuation
- Projects estimated cash flows over an assumed holding period and exit, usually ARY
- Cashflow is then discounted back to the present day usually at a discount rate (desired rate of return), reflects perceived risk
Short leaseholds/phased developments/overrented properties
What would the profits method be used for?
- Used where the value of the property depends upon the profitability of its business and its trading potential
- Used for pubs, petrol stations, hotels and care homes
- Must have accurate and audited accounts for 3 years
Can you talk me through the profits method?
Income - costs = gross profit - less expenses & operator’s remuneration = Fair Maintainable Operating Profit (FMOP)
Expressed as EBITDA (earnings before interest, taxation, depreciation and amortisation)
Capitalised at yield
When would you use contactors / depreciated replacement cost method?
Used for owner-occupied or specialised property that is rarely sold on the open market
Can you talk me through the contractors method?
- Value of land in its existing use (assume plannign permission exists)
- Add current cost of replacing the building plus fees less a discount for depreciation and obsolescence (use BCIS and then judge level of obsolescence)
When would the residual method be used?
- **Must be market led, only used to calculate land value **
- GDV of scheme at today’s date assuming current market
- Comparable method used to establish rent and yield (ARY)
- Rnet free and void periods can be assumed and purchaser’s costs are usually deducted
Why is PII important when undertaking valuation work?
- It is important to cover my firm & provides security for the bank lending against the property
- It is important to clearly set out the limitations of PI cover in the terms of engagement
What is the PI limit for loan security valuation?
25% of the market value
What does the Global Standards (UK National Supplement 2023) set out?
- Outlines specific requirements and guidance for applying the global standards to valuations in the UK
- It’s a supplement, not a replacement, of the Red Book Global Standards, and it clarifies how to apply them in the UK context
UK Valuation Practice Guidance Applications (VPGA) in the National Supplement?
- Valuation for financial reporting
- Valuation of charity assets
- Relationship with auditors
- Valuation for commercial secured lending purposes
- Valuation for UK residential property
- Valuation of registered social housing for loan security purposes
- Valuation for Inheritance Tax, SDLT and ATED
How do you value owner occupied?
Value at VP and use speculative investor (assume initial void period & RF)
What are the two definitions of a valuer?
- Internal - no third party reliance
- External - no material links with the asset to be valued or the client
How do you value a property that is over rented?
- Hardcore layer method
- Top slice is at a more risky yield
- Market rent is at a more stable yield
What purchaser’s costs are deducted to arrive at market value?
- Allowance for SDLT
- Agents and legal fees plus VAT = 1.8%
What is the current rate of SDLT payable for commercial property?
£0 - £150k = £0
£150,001 - £250k = 2%
Over £250k = 5%
What are the implications of undertaking a desktop valuation?
The valuation is only based on assumptions as to the nature and condition of the property which will impair its accuracy
On what basis do you value for accounting purposes?
Fair value as stated in VPGA1 as per Red Book
Can you talk me through the instruction (loan security valuation)?
- Provide a fee quote and check competence
- Confirm there are no conflicts of interest
- Bank instructs us, the terms of engagement was in line with our Serviced Level Agreement
- The valuation date was confirmed which in this instance was the day I inspected
- Signed by both parties
What info documents would you gather prior to inspecting?
- Lease
- Title documentation
- Floorplans
- Planning info
- EPCs
What would be a typical special assumption?
Market value on the assumption of VP
When setting up the inspection what do you need to think about?
- Surveying safely
- If by yourself - lone working policy
What due diligence is required prior to inspecting for valuation purposes?
- Asbestos information and survey
- Fire risk assessment
- Disability discrimination audit
Example 2 - Loan security val
What were you noting on-site internally & externally?
- Age of the building (refurbished in 2017)
- Construction - reinforced concrete and externally cladded
- Lighting - LEDs
- Internal fit out - raised floors
How did you determine the yield to apply to the passing rent?
Comparable method - sourced investment sales of similar properties taking into account lease terms & tenant covenant strength
Following lease expiry or breaks what do you need to do?
- Take into account void period & rent free & reletting costs (10% of rent)
- In this case 12 months void & 12 months RF
What adjustment did you make to the yield to the reversionary income?
Made a 0.5% adjustment to reflect future uncertainty & risk
What did you consider for your Opportunities and Threat in your SWOT analysis?
Opportunities - let the vacant space and increase in rent
Threat - continuing impact of higher interest rates on the wider property market
What is a lender action point?
If an EPC has expired identifying this
What are the three types of obsolscence?
- Physical - result of deterioation/wear and tear over the years
- Functional - the design or specification of the asset no longer fulfills the function for what it was originally designed
- Economic - due to changing market conditions for the use of the asset
Before commencing a valuation instruction, what are the three steps to undertake?
- Are you competent to undertake this work?
- Check for any conflicts or personal interests?
- Set out in writing your full confirmation of instructions to the client prior to starting work and receive written confirmation of instruction
Why is statutory due diligence undertaken for valuations?
Required to check that there are no material matters which could impact the valuation
What are some examples of statutory DD?
- asbestos register
- contamination
- equality act 2010 compliance
- EPC rating
- fire safety compliance
- legal title and tenure
- planning history
What is the timeline of an insutrction?
- Receive instruction from the client
- Check competence and independence
- Issue ToE, receive signed ToE
- Gather info/DD/market research/comparables
- Inspect and measure
- Undertake valuation
- Draft report
- Finalise and sign report
- Rpeort to client
- Issue invoice
- Ensure file is in good order to acheive
What is an all risks yield?
Rate of interest, fully let at MR, reflecting prospects and risks
What is a true yield?
Assumes rent is paid in advance not in arrears
What is a nominal yield?
Initial yield assuming rent is paid in arrears
What is a gross yield?
The yield not adjusted for purchaser’s costs (auction)
What is an equivalent yield?
Average weighted yield of reversionary and initial yield
What is an initial yield?
Simple income yield for current income and current price
What is a reversionary yield?
MR divided by current price - asset let below MR
What is a running yield?
The yield at a point in time
What is Net Present Value?
Sum of the DCFs for the project - NPV can determine if the investment will give a positive/negative return against a target rate of return
What is the IRR?
- The rate at which all future cashflows must be discounted to produce NPV of zero
- IRR = total return from an investment opportunity if no software to calculate can use liner interpolation
UK VPS 3 - Regulated purpose valuations
Relied upon by 3rd party who haven’t commissioned the valuation
What are the 5 purposes of the VPS 3 valuations?
- Financial statements
- Stock exchange
- Takeovers / mergers
- Collective investment schemes
- Unregulated property unit trusts
What does the VPS 3 also state? Can only value if…
- Company has not acted for purchase in last 12 months
- Must state if more than 5% of annual fees
- 7-year rotation policy
What are some of the recommendations from the Peter Pereira Gray Review (Dec 2021)
Commissioned by the RICS Standards & Regulatory Board
- Governance arrangements for high-risk and regulated vals
- Separation of valuation from advisory services within firms
- Developing time-specific rotation for valuers
- Developing Valuation Compliance Officer within firms
- Process to raise issues on ethical conduct in firms
- Establishing a vals regulatory quality assurance panel
What does the RICS Guidance Note: Sustainability and ESG state?
- Includes advice on ToE, valuation purpose, inspection, reporting
- Relevant sustainability characteristics, considerations, and risks
- How these should be reflected in the choice of valuation method
What is the Margin of Error?
Range allowed by courts in respect of valuation
K/S Lincoln v CB Richard Ellis (2005) reinforced +/- 5% but if one off commercial property +/- 10%
What is hope value?
- Arising from expectation that future circumstances may change
- Future prospect of the site gaining planning permission
- The realisation of marriage value from merging interests
‘An element of market value in excess of the existing use value, reflecting the propsect of some more valuable future use’
What is marriage value (synergistic value)?
- Merger of interests - physical or tenurial
- Before and after valuations
- Negotiated outcome - usually shared 50/50 of uplift or pro rata
‘An additional element of value created by the combination of two or more assets or interests where the combined value is more than the sum of the separate values’
What is an assumption?
Reasonable for valuer to accept something is true without the need for specifcation (e.g. building is structurally sound)
What is a special assumption?
Assumption that is taken to be true and accepted as fact even though it is not true (e.g. VP)
What is zoning?
- Valuation technique, comparison of retail properties as rental value reduces away from the shop frontage
- Halving back principle 6.1m zones
What does the Rights of Light (RICS Guidance Note 2016) state?
RoL - arises 20 years after uninterrupted enjoyment of light without the consent of the 3rd party by way of an easement
What yields were your comps?
Net initial yields
Can you talk me through your desktop valuation?
- Initially assessed market rent by researching comparable evidence and made adjustments when comparing to the subject property
- I then calculated market rent to determine if the property was above or below passing rent
- I also researched yield evidence taking into account covenant strength and lease term as well as tenure and location
- Then I would determine the yield to be applied to the term income up to the lease event
- Then I would adopt a 12 month void to re-let and 12 month rent free before applying a weaker yield to the reversion income to reflect the risk & uncertainty & deducted purchaser’s costs
Can you talk me through your loan security valuation example?
- I reviewed the tenancy schedule to check tenant covenant strength and the leases to check the lease term remaining and break and RR provisions
- After researching rental comp evidence and making adjustments I then applied my opinion of MR psf to the floor areas of the property to determine MR
- The tenants withint the property were all of a similar covenant strength so I adopted the same yield on the passing rent up to the lease event
- All of the rents were below passing rent
- Following the lease event, I then adopted my opinion of MR adjusting the yield to reflect the level of risk and applied a void & rent free in perpetuity (deferring by the relevant number of years for the term) to the reversion income
- I then deducted purchaser’s costs to arrive at my opinion of MV
How would you value if on a VP/owner occupied basis?
- Usually apply vacant sales comparables and adopt a rate psf
- I don’t deduct purchaser’s costs as comp evidence tends not to factor in purchasers costs
How would you value a leasehold?
- Value at profit rent
- Only capitalise to lease event
- Apply more risky yield
Why is a lease renewal less best evidence than open market letting?
Because it is not an arm’s length transaction
What are you looking at for when reviewing a tenancy schedule?
Looking at lease events such as RR’s, breaks & expiries and tenant covenant strength
What are the limitations of a desktop study?
- Not inspecting and measuring the property
- Relying on measuremetns which may not be accurate and there may have been changes to physical characteristics or building or condition
What is the difference when valuing on a leasehold and freehold?
- A leasehold value is only over the period of the lease and would need to determine whether there is any element of profit rent
- Adjust the yield to reflect it is on a leasehold basis rather than a freehold basis - would be typically 1%
