Valuation 3 Flashcards
Why is the YP single rate table also known as the Present Value of £1 per annum?
It tells us the present value of a pound to be received each year for a given number of years
What are the principle sources of investment?
Gilts (UK Government Bonds)
Equities (Shares in Companies)
Property
What is a bond investment?
A bond investment has a fixed return for a fixed period at the end of which the capital is repaid
What is the major attraction of property over the other two major investment opportunities?
With proactive management you can improve performance (e.g. refurbish units, regear leases). With a gilt or a company you have shares in - you can’t improve it’s performance easily.
What are the major disadvantages of property over the other two major investment opportunities?
Low liquidity - You can buy/share equities and guilts almost instantly, but with property it takes a long time to get into it
Property investment has a higher level of risk and difficulties than investing in gilts etc. therefore an investor will require a higher yield to compensate.
Requires active management (easiest to let FRI)
High transfer costs (agent fees)
Not divisible
How did the all risks yield get its name?
Takes into account all the risks of the investment
What is the all risks yield?
Overall return an investor can expect from a property, accounting for both the rental income and the risks associated with the investment
What is another name for the all risks yield?
Market capitalisation rate
What is a gross yield?
The rent expressed as a percentage of the purchase price
What is a net yield?
Is rent expressed as the percentage of the gross acquisition price (i.e. purchase price plus purchasers costs)
Name the costs that a purchaser must incur with acquiring a property investment? (gross acquisition costs)
Stamp Duty Land Tax
Agents Fees
Legal Fees
Non-recoverable VAT on Fees
Quantify purchaser’s costs in percentage terms
STAMP DUTY:
0% on the first £150K
2% on the next £100K
5% above £250K
For purchases above £250K the SDLT can be calculated from the Gross Acquisition Price net of agent and legal fees.
Agents Fees - 1%
Legal Fees - 0.5%
VAT on Fees - 20% (of the 1.5% which is 0.3%)
Total for fees (inc VAT) is 1.8%
What would you do if you had to value an investment property but could not find any evidence of yields?
You would construct a yield
Look at gilts, as they are a risk-free investment, and then add a risk premium
Take into account market risks and property risks
Deduct growth (note: no growth if in recession)
How is rental and capital growth accounted for in a conventional investment valuation?
It’s included in the all risks yield
The greater the growth opportunity, the lower the yield
What is a reversionary investment?
A reversionary freehold is an investment that is let at a rent other than Market rent (under-rented or over-rented).
There are two approaches to value a reversionary investment.
Term and reversion
Hardcore/ layer method
Explain the process of the term and reversion technique?
We capitalise the passing rent until review or reversion (to market rent)
(Do this, by multiplying the passing rent by the YP for the number of years to the reversion)
We take the market rent to be received at review/reversion and then capitalise that into perpetuity (gives value at that moment in time)
We then defer it further, at a PV of £1, for the period of the term
The reversion gets capitalised at market rented rate, but the term gets capitalised at a lower rate due to the lower risk (if over-rented, then term would have higher yield and reversion would have lower yield)
Explain the process of the hardcore/layer technique?
We capitalise the rent passing into perpetuity
We then take the additional rent that we expect to receive at review/reversion and we capitalise that into perpetuity
This gives top-slice value at that moment in time
We need to defer it for the period of the term
The bottom slice is capitalised below market rented rate due to reduced risk, and the top slice is capitalised above this rate to reflect the increased risk
There is risk at review that you won’t receive the additional rent (it could be argued that the rent review etc. is not agreed yet so the investment as a whole must have a higher risk attached to it than a market-rented investment).
How would you value an over-rented investment?
Can use either:
Term and reversion
Hardcore or layer
Both blocks and slices would be capitalised at an above market rented rate
Use block income (another name for term and reversion) or core income techniques
Need to capitalise market rent into perpetuity and then capitalise the top-slice income (the over-rented portion) up to review/reversion
What is an initial yield?
the net income (or passing rent) at the date of purchase expressed as a percentage of the Purchase Price
What is a reversionary yield?
the Market Rent expressed as a percentage of the Market Value (or Purchase Price)
What is the running yield (straight yield)?
Present income expressed as a percentage of market value
What is an equivalent yield?
the weighted average of the Initial Yield / Running Yield and the Reversionary Yield
Weighted average = takes into account the importance, rather than treating each item equally
The weighted average is always closer to the reversionary yield than to the initial yield
It can also be described as the internal rate of return from an investment disregarding any rental or capital growth
What is an equated yield?
It is the overall rate of return, taking into account the growth
It is the true investment yield
It is the discount rate at which the DCF equals the purchase price of the investment
What is a true equivalent yield?
It is the yield, when taking into account that rent is received quarterly in advance (rather than the nominal yield which is generated when rent is received annually in arrears)
(does not affect valuation)
What is top-slice income?
Additional rent expected at review/reversion when under rented
Overage/froth
Leasehold profit rent
How is top-slice income valued?
Capitalised above the market rented rates to reflect the increased risk
(i.e. at a higher rate than bottom slice income)
The risk is on receiving the extra proportion of rent (not the rent that we are already receiving)
How would you value a leasehold interest / ascertain if a premium can be charged for the assignment of a lease?
Only has value if there is a profit rent and an unexpired lease term of more than one year
Answer: I would capitalise the profit rent (the market rent less the rent paid)
If you get asked, can then say, would capitalise via the YP single rate, the YP dual rate, or the YP dual rate tax adjusted.
What are the names of the two yields in the YP dual rate? (can come up when discussing assignments)
Accumulative rate
Remunerative rate
Which is the sinking fund rate?
Accumulative rate
What effect does rent received quarterly in advance have on the yield?
It increases it (becomes the true equivalent yield rather than the nominal yield)
What is the fundamental difference between conventional investment valuation techniques and discounted cash flow techniques?
In conventional investment valuations, growth is implicit in the capitalisation rate (i.e. we do not calculate future rental and capital growth so investor may accept low yield as they are expecting growth)
In a DCF, we make the growth explicit - we calculate what future values are going to be (i.e. we build in the growth and calculate what the future rent/future market value would be)
IN DCF we discount with growth at the invested target rate of return
Note: RICS’ publication of new global practice information on using explicit discounted cash flow (DCF) valuations for investment property (NOV 2023)
How is growth calculated in a discounted cash flow?
We compound it using (1+i)^n or Parry’s Amount of £1 Table
How would you arrive at a discount rate when carrying out a discounted cash flow?
UK Government Stock (Gilts) form the basis of yields
Start with risk free rate and add on market risks and property risks
Take risk free rate and add the risk premium
What is a risk-free rate?
The yield from UK Gilts
What do you understand by the expression risk premium?
The return over and above Government Stock, that the investor will require
The yield an investor would require that is over the yield from gilts
Why do property investors require a risk premium?
Because there is more risk and more difficulty investing in property than there is investing in gilts (Government Stock/Government Bonds)
What is BOE base rate & inflation?
4.5 & 2.6%
The Years Purchased in Perpetuity is calculated as
100/yield
How is present value calculated?
By discounting the future cash amount/ property value at the appropriate discount rate
How would you carry out a DCF?
estimate the cashflow (income less expenditure)
estimate the exit value at the end of the holding period
select a discount rate
discount the cashflow using the discount rate to give an NPV (which is the Market Value)
What impact does the tenant paying monthly have on valuation?
The yield would increase to reflect greater risk
What does Red Book say we have to do before doing valuation + after that?
Establish competence, conflict of interest and agree terms of engagement
Inspect, note limitations, purpose of valuation, basis of value and assumptions/special assumptions
