Valuation Flashcards
What do you do when you are given a valuation instruction?
1) Competence -> Skills, Understanding, Knowledge (SUK)
2) Independence -> think then check for CoI
3) Terms of Engagement -> full confirmation of instructions -> written acceptance
What is statutory due diligence
- Flooding
- Legal title
- Planning history and compliance -> always value the consent
- Asbestos register
- Contamination
What are the methods of valuation?
1) Comparative method
2) Investment method
3) Residual method
4) Profits method
5) Depreciated replacement cost
What are the approaches to valuation? Where are they defined?
VPS 5 / IVS 105
The overall manner in which a valuation is undertaken to determine the value of an asset.
1) Income approach -> converting current and future cashflows into a capital value (investment, profits, residual method)
2) Cost approach -> reference to the costs of the asset (DRC)
3) Market approach -> comparable evidence
Talk me through your approach to the comparable method?
1) Identify comparables
2) Verify information
3) Assemble in a schedule
4) Adjust using the hierarchy of evidence
5) Analyse to form opinion of value
6) Report value and prepare file notes
What covers comparable evidence?
RICS Guidance Note Comparable Evidence in Real Estate Valuation 2019
How do you determine what is a good comparable?
“The valuer should use professional judgement to assess the relative importance of evidence on a case-by-case basis”
Have reference to the hierarchy of evidence
What is the hierarchy of evidence?
- Category A: Direct Comparables
- Category B: General market data
- Category C: other sources
What is category A evidence?
Direct comparable evidence
Contemporary, completed transactions of near identical properties with full accurate information – may include from within subject property, similar properties
Can also use partially complete verified evidence from similar transactions
Similar real estate being marketed where offers have been made but are non-binding
What is category B evidence?
General Market Data
Commercial databases (depending on their reliability) e.g. Land reg
Indices
Historic evidence
Demand/supply data
What is category C evidence?
Other sources
Other types of property and other locations
Other background data
How do you deal with a shortage of evidence?
Doesn’t stop a valuation taking place -> more emphasis on skills, expertise, and judgement of the valuer
Needs to look further afield and across a wider range of indicators
What does the Red Book say about a lack of comparables?
Red Book allows for reporting of uncertainty -> uncertainty due to lack of comparables is common, so make clients aware
VPS 3 – comment on any material uncertainty…to ensure clarity on the part of the valuation user
What is the investment method?
Conventional method: Capitalisation rate applied to rent = capital value
What is the term and reversion method? When is it used?
For reversionary income streams (market rent > passing rent)
Term capitalised until lease event, reversion capitalised into perpetuity
What is the layer/hardcore or topslice method? When is it used?
Use for over-rented property (passing ren > market rent)
Divided horizontally: top slice = excess rent passing
Higher yield applied to top slice to reflect additional risk
What is an all risks yield?
The remunerative rate of interest used in the valuation of a fully let property let at market rent reflective all the prospects and risks attached to the investment
What is a yield?
A measure of risk e.g.
o Quality of location, tenant covenant, lease terms
o Prospects for rental and capital growth
o Voids
o Obsolescence
o Liquidity
How do you determine a yield?
Comparable evidence
What is the relationship between yields and growth?
Yields are growth implicit (unlike DCFs)
What is years purchase?
YP = 100/yield -> number years required for investment to payback purchase price
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 (e.g. auction result)
What is a net yield?
The yield adjusted for purchaser’s costs
What is an equivalent yield?
Average weighted yield when a reversionary property is valued using an initial and reversionary yield
What is an initial yield?
Simple income yield at current income and current price
What is a reversionary yield?
Market rent over price for an asset which has rent passing below market rent
What is a running yield?
A yield at any moment in time
When do you use the profits method?
Used for trade related property where there is a monopoly
Value of the property depends on the success of the business
E.g. Pubs, petrol stations, hotels, care homes
Make use of audited accounts (or management if none audited)
How does the profits method work?
Evaluate gross income for past 3 years
Establish Fair Maintainable Turnover (FMT)
- What is normal income, normal expense
- Less costs and purchases (= gross profit)
- Less reasonable working expenses (=unadjusted net profit)
- Less operator’s profit
= adjusted net profit aka Fair Maintainable Operating Profit (FMOP)
Capitalise at appropriate yield
Assumes a Reasonably Efficient Operator (REO) -> similar concept to income purchaser
When do you use the DRC?
Used for specialist properties where there is no comparable evidence
E.g. Submarine base, oil refinery, schools, docks etc
Method of last resort
How does the DRC work?
1) Calculate cost of constructing a modern equivalent asset
2) Depreciate the cost to reflect current asset quality/obsolescence
3) Calculate cost or value of equivalent piece of land
4) Add the two
What is obsolescence?
Physical – wear and tear
Functional – design makes its use impracticable
Economic – changing market conditions
When do you use the residual method?
Used to assess the viability of a development scheme or residual land value
What constitutes development costs?
Site preparation Statutory costs (S106 / CIL) Build costs Professional fees (5-10%) Contingency (10-15%) Purchasers costs (1% sales agents, 0.25% legal fees) Marketing costs Finance costs Developers profit
What is finance cost? How is it calculated and treated?
Risk Free Rate -> BoE base rate, LIBOR (ending 2021)
100% debt finance -> don’t know cost of capital for firms
Compound interest across lifetime of development
Why do developers borrow money? How do they differ in an appraisal?
1) Site purchase -> compound interest on a straight-line basis
2) Development costs -> S curved over development
3) Hold over costs -> compound interest on a straight-line basis
How do you do sensitivity analysis?
1) Simple sensitivity -> one variable
2) Scenario analysis -> change scenarios
3) Monte Carlo simulations -> multiple situations using probability
Where is info on development valuations?
RICS Guidance Note Valuation of Development Property 2019
Effective 1st Feb 2020
Designed to complement IVS 410 “development property”
Gives an overview of how to value development property
RICS Guidance Note Valuation of Development Property 2019 - what are the key points
- Complements IVS 410 Development property
- Valuations must be undertaken in 2 ways
- DCF vs Residual
- Risk Analysis/sensitivity should be undertaken
How much are professional fees roughly? What are they made up of?
5-10% construction costs inclusive of VAT
Architects, valuers, surveys
What is BCIS? How do you use it?
Build Cost Information Service
Index of tender prices
Can select index based on asset type and location
Provided in sqm on GIA
What the difference between a development appraisal and a residual?
Residual land valuation used to estimate the land value of a site. Uses market inputs.
Development appraisal is used to estimate the profitability or viability of a site. Uses specific inputs
What are the pros and cons with residuals/DAs?
Flexible
Clearly show assumptions
Simple
Standard outputs
Based on a lot of assumptions Highly sensitive to changes in inputs Use 100% debt Time value of money not accounted for No growth assumptions
What is reinstatement Cost?
Figure provided for insurance purposes
Not a written opinion of value
Uses BCIS
Valuation of development as it currently exists without developers profitq
What is the margin for error for a valuation?
Depends on the type.
Case law dictates approximately 5% resi, 10% commercial, 15% unique factors
What is a restrictive covenant? What is an easement?
Restrictive covenants - obligation to do/not do something e.g. repair a wall
Is a legal agreement that runs with the land. Can be insured against
Easements - A right over someone else’s land e.g. right of way, right to light
How has Grenfell impacted valuations?
1) Need EWS 1 forms to confirm no flammable materials
What is typical contingency and what impacts it?
5-10%
Construction cost risk, construction delay risk, unforeseen factors eg contamination
What is typical PoC and what impacts it?
15-25%
Sales risk, location, potential pre-sales, purchaser profile, market conditions. Also planning permission risk. Demand for the site by other developers.
What is typical marketing costs?
Typically around 1% of GDV but varies - depends on what it is and who you are targeting (e.g. going abroad or domestic)
What is typical finance costs?
5-6%
Site location, developer size/covenant, risk free rate
What impacts sales agents and legal fees?
Scale of development. Typically 1% and 0.5% but will be lower if a very high value scheme. Could be 2% agents for a smaller project
