Valuation Flashcards
What are the two commonly used financial reporting standards used in the UK?
IFRS (International Financial Reporting Standards); principles-based
UKGAAP (Generally Accepted Accounting Practice in the UK); rules-based
Why would you undertake research on flooding risks?
This may detrimentally impact on the marketability and valuation of the property as it may be difficult to or expensive to obtain insurance – use Environment Agency website to check the flooding risk
What is a valuation?
An opinion of the value of an asset or liability on a stated basis, at a specified date
What is the role of a valuer?
Red Book (Global): to assess value in the light of evidence normally obtained through analysis of comparable transactions.
What is the definition of an internal and external valuer?
Set out in RICS Valuation – Professional Standards 2018 (Red Book)
Internal Valuer – A valuer who is employed by: either the company that owns the assets, or the accounting firm responsible for preparing the company’s financial records. Valuation if for internal use only with no third-party reliance. Generally capable of meeting the requirements of independence and professional objectivity in PS 2, but may not always be able to satisfy additional criteria for independence specific to certain types of assignment.
External Valuer – has no material links with the client, agent or asset to be valued.
What makes up the Purchaser’s Costs?
Blended rate 4.99% (max.) SDLT
1% Agent fees +VAT
0.5% Legal fees +VAT
What is a yield?
Yield are a measure of investment return. They show the income expressed as a percentage of capital invested.
(Income / price) x 100
Yields are growth implicit
Explicit and Implicit Growth – What is the difference?
It refers to how the prospect of future rental growth, beyond the Estimated Rental Value at the valuation date, is considered in the valuation.
Implicit* means the prospect for rental growth is factored into the yield, therefore if there is anticipation rents will improve over the coming years from the existing ERV today, an investor will pay a keener (smaller) yield in anticipation of a larger yield becoming receivable in the near future.
Explicit means the prospect for rental growth is factored into the expected rental cashflow, by “growing the rent” manually from the current ERV to predicted future levels using informed assumptions. In other words the rent is grown “explicitly” from its ERV today.
*In Investment Valuation, unless requested otherwise, we use factual information as at the valuation date. Our valuations are therefore growth Implicit**
Before commencing a valuation instruction, what three steps must you first undertake?
CIT.
Competence – do you have correct levels of skills, understanding and knowledge? (SUK). If not, refer to RICS Find a Surveyor tool
Independence – check for any conflicts or personal interests
Terms of Engagement – set out in writing full confirmation of instructions prior to starting work
confirm competence of valuer
the extent and limitations of valuer’s inspections must be stated
What statutory due diligence are you required to carry out when undertaking a valuation, and why?
To check that there are no material matters which could impact the valuation.
Asbestos register, business rates/council tax, contamination, Equality Act compliance, environmental matters (high voltage power lines, electricity sub-stations, telecom masts etc), flooding, H&S compliance, fire safety compliance, highways (check roads adopted), legal title and tenure (check boundaries, ownership, any deeds of covenant, easements, rights of way, restrictive covenants, wayleaves), public rights of way (from an OS sheet), planning history and compliance (check any onerous planning conditions, conservation area, listed, whether subject to s.106/CIL)
What would be the timeline of a valuation instruction?
- Receive instructions from client
- Competence (Skill, Understanding, Knowledge)
- Independence f
- Terms of engagement to the client (CIT)
- Receive terms of engagement signed by client
- Gather information – leases, title documents, planning information, OS plans etc.
- Undertake due diligence – check information for any adverse material matters
- Inspect and measure
- Research market and assemble, verify and analyse comparables
- Undertake valuation
- Draft report
- Have valuation and report considered by another surveyor for checking purposes
- Finalise and sign report
- Report to client
- Issue invoice
- Ensure valuation file in good order for archiving
What are the five main methods of valuation?
- Comparative method
- Investment method
- Residual method
- Profit method
- Depreciated Replacement Cost method (Contractors)
What are the widely accepted valuation approaches under the IVS 105?
Income approach – converting current/future cash flows into a capital value (i.e. Investment, Residual, Profits method)
Cost approach – reference to the cost of constructing the asset (i.e. Contractors/DRC method)
Market approach – using comparable evidence (i.e. Comparable method)
What is the methodology of the Comparable method of valuation?
- Identify comparables
- Verify details, analyse headline rent to give net effective rent
- Assemble comparables in a schedule; matrix with weighting
- Adjust comparables
- Analyse comparables to form an opinion of value, stand back and look
- Report value
What RICS guidance would you have regard to when using the comparable method?
New Guidance Note (Comparable Evidence in Real Estate Valuation 2019) published in October 2019.
Scope:
1. principles of the use of comparable evidence
2. encourage consistency
3. issues of availability of comparable evidence
4. potential sources
RICS Information Paper on Comparable Evidence in Property Valuation 2012 (ARCHIVED in 2018, but still useful)
How do you find relevant comparables?
Inspection of an area to find agent’s boards
Visit/speak to local agents
Auction results (beware that these are gross prices, and may also be special purchaser/insolvency sale)
In house records
Databases and websites, such as EGi, CoStar, Rightmove, Lonres
How would you analyse rent free periods and headline rents?
The process of devaluing a headline rent with a rent-free period to equal a net effective rent
3 months fit out is typically deduct from rent-free period as its market standard
Main approach:
1. Straight line method (either until lease expiry or next rent review/lease event)
Could:
2. Use of DCF
What is the headline rent?
The rent payable under lease terms after all incentives have expired, such as a rent-free period.
It is an artificially inflated value. Does not represent the true market rental value, however helps to sustain the capital value of the property particularly as rent reviews are upwards only.
Tenant agrees to this as they benefit from a relief period via the incentives.
What is price?
Actual observable price in the open market.
What is value?
An estimate of the price that would be achieved if a property were sold in the market.
What is worth?
A specific investor’s perception of the sum he would be prepared to pay (or accept).
What is net effective rent? How is it calculated?
The headline rent minus any incentives, to lease expiry or next lease event.
Rent x (Term – Rent Free)
÷
Full Term
What is the hierarchy of rental evidence?
The relative weight attached to different types of evidence
- Open market lettings
- Lease renewals
- Rent reviews
- Third party determinations (independent expert)
- Sale and leasebacks
- Asking rents
What is the investment method of valuation?
Used when there is an income stream to value. The income is capitalised using a yield to produce a capital value
Conventional method assumes growth implicit approach – implied growth rate is derived from the market capitalisation rate (yield).
How do you choose which investment method approach you will use?
Depends on several factors, including:
- Establish if over- under- or rack-rented
- Company preferences and software
- The reversion in terms of time and rental value
What are the different types of methodologies you would use with the investment method?
Conventional method Term and Reversion Hardcore and layer method Hardcore and top slice method DCF
Tell us about the conventional method
Rent received or Market Rent x YP = Market Value (rent/yield comparables important)
Growth is implicit in the yield.
Tell us about the term and reversion method
It is used for REVERSIONARY (under-rented) investments
Income flow is divided vertically.
Term (passing rent) is capitalised until next lease event (review/expiry) at an INITIAL yield
Reversion to Market Rent valued in perpetuity at a reversionary yield
There is a yield differential; term at a keener yield to reflect lower risk.
Tell us about the hardcore and layer method
It is used for REVERSIONARY (under-rented) properties. Typically used by the institutional investment market, and used when the reversion is close in time.
Income flow is divided horizontally. Both the hardcore (PR) and layer (MR-PR) are valued into perpetuity, but the layer is deferred to the next lease event.
An Equivalent Yield is applied to both the hardcore and layer.
Argus Val Cap uses this method.
Tell us about the hardcore and top slice method
It is used for OVER RENTED investments.
Income flow is divided horizontally. The hardcore (MR) is valued into perpetuity at a net initial yield.
The top slice (PR-MR) is capitalised to next lease event at a net initial yield with a risk adjustment.
There is a yield differential; top slice at an inflated yield to reflect higher risk of over-renting.
Different yield type can be used based on market comparable evidence.
NO PV of £1 needed as both layers of income are being received NOW.
What is the All Risks Yield (ARY) and what does it reflect?
The remunerative rate of interest used in valuation of fully let property let at Market Rent reflecting all the prospects and risks attached to particular investment.
It is an implicit method of valuing, as risk and rental growth is wrapped up in the yield.
Prospects/Risks include: obsolescence, voids, etc.
Can be used to value reversionary properties – just apply same ARY to the term and reversion.
Is a rack-rented of reversionary property more risky?
Reversionary always carries more risk than rack-rented because a greater proportion of the value is reliant on future market rental values which are not certain.
Tell us about the DCF method
Usually used for worth calculations for a specific investor. They have a target rate of return.
A growth explicit investment method of valuation.
Project the assumed cashflows over the assumed holding period to exit, enter an exit value, then discount the cashflow back to today at an investor’s target rate of return.
For what valuations is DCF method typically used?
Used for a number of valuations where the projected cash flows are explicitly estimated over a finite period e.g.
- Short leasehold interests
- Properties with income voids
- Phased development projects
- Non-standard investments (say with 21 year rent reviews)
- Over-rented properties
Why do we discount in a DCF?
To reflect the time value of money. The discount rate will always reflect the investor’s perception of risk. Also known as the capitalisation rate.
What risk factor may affect the DCFs discount rate?
Must be careful not to double count risk in discount and factored as an explicit factor.
- Exercising lease breaks
- Illiquidity on sale
- Failure to meet market rental expectations
- Location
- Legislative changes
- Void risks/failure to re-let
- Tenancy default (covenant risk)
What is the PV of £1 formula?
PV of £1 = 1
÷
(1+i)n
‘i’ is the yield that the valuer thinks is appropriate.
‘n’ is the term in years (to next rent review)
What is the Years Purchase?
The relationship between the income and the capital value.
The number of years it will take for the annual income to add up to the capital value, when taking into account the time value of money (i.e. that it’s decreasing). i.e. the right to receive £10,000pa for 4 years won’t = £40,000 payment today.
What is the Years Purchase formula?
Work out the PV of £1 first. YP = (1-PV of £1) ÷ i
‘i’ is the yield that the valuer thinks is appropriate.
What is the Years Purchase into perpetuity formula?
Used for valuing the reversionary rent into perpetuity.
100 ÷ i
Will need to work out the PV of £1 in X number of years when the reversion begins and multiple by the above YP.
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 is the Net Present Value (NPV)?
The sum of the discounted cash flows of a project
Used to determine if an investment gives a positive return against a target rate of return
Positive NPV – investment has exceeded investor’s target rate of return
Negative NPV – investment has not achieved investor’s target rate of return
What is the Internal Rate of Return (IRR)?
The discount rate which produces an NPV of zero when used to discount the cashflow
If valuer does not have software to calculate the IRR then linear interpolation can be used to estimate the IRR
How do you calculate the IRR?
- Input current market value as a negative cash flow
- Input projected rents over holding period as a positive value
- Input projected exit value at end of the term assumed as a positive value
- Discount rate (IRR) is the rate which provides NPV of zero
When would you use the Profit method of valuation?
For valuations of specialist trading properties or entities, where there is a ‘monopoly’ position
Where the value of the property depends upon the businesses trading potential
i.e. pubs, petrol stations, hotels, care homes, cinemas, golf courses
What is the Profit method of valuation?
Valuation method used where value of property depends on the profit generated from the business, not physical building or location.
Must have accurate and audited accounts for 3 years if possible, or estimates if needed for a new business
What is the simple methodology to undertake a Profit method valuation?
(Annual Turnover – Costs/Purchases) = Gross Profit
(Gross Profit – Reasonable Working Expenses) = Unadjusted Net Profit
(Unadjusted Net Profit – Tenant’s /share) = Fair Maintainable Operating Profit (FMOP)
CAPITALISE at an appropriate yield to achieve capital value
Cross check with comparable method if at all possible
When is the Contractor’s method (Depreciated Replacement Cost) used?
It is a method used where direct market evidence is limited or unavailable for specialised properties (i.e. sewage works, lighthouses, schools).
The method has 3 purposes:
1. used for owner occupied property
2. used for accounts purposes for specialised properties
3. used for rating valuations of specialist properties
Is the DRC method Red Book compliant?
It is NOT suitable for Red Book compliant valuations for secured lending
It can be used to calculate Market Value for specialised properties only for valuations for financial statements
How do you undertake a Contractor’s/DRC valuation?
- Value of land in its existing use (assuming planning permission exists)
- Establish the replacement cost of the building PLUS Fee MINUS discount for depreciation* (use BCIS and then judge level of obsolescence)
Add the two together
*Estimate amount of depreciation appropriate for physical, functional and economic obsolescence
When was the RICS Valuation – Global Standards 2017 (‘Red Book’) effective from?
Issued June 2017, effective from 1 July 2017
When was the Red Book’s UK National supplement effective from?
Issued November 2018, effective from 14 January 2019
What is the Red Book?
Global Professional Standards that define procedural rules and guidance for carrying out Valuations.
The Red Book comprises the RICS Valuation – Global Standards 2017 and the UK national supplement (Issued November 2018, effective from 14 January 2019).
Made up of 2 PS (professional standards), 5 VPS (valuation performance standards) and 10 VPGAs (valuation practice guidance applications). IVS 2017 are included in full at the end.
What is the Red Book’s purpose?
COT.
Consistency, objectivity, transparency
- Consistency in approach
- Credible and consistent valuation opinions
- Independence, objectivity, transparency
- Clarity regarding TOEs
- Clarity regarding Basis of Value
- Clarity in reporting relevant matter in the report
Reduce the risk of negligence claims - “Framework for best practice”
What does the Red Book NOT do?
Instruct members on how to value in individual cases
Prescribe a format for reports
Override standards specific to jurisdictions
Who does the Red Book apply to?
All members and regulated firms MUST comply with Parts 3 and 4 of the global Red Book.
Part 3 – PS 1 and 2
Part 4 – VPS 1-5
