Valuation

Question 1

Definitions of internal v external valuer

Answer 1

Internal valuer
- employed by company to value assets of company
- valuation for internal use only
- no 3rd party reliance
External valuer
- has no material links with asset to be valued or client

Question 2

Commencing a valuation instruction

Answer 2

1. Competence
   - correct level of skill, understanding, knowledge
   - if not, refer to RICS Find a Surveyor service on RICS website
2. Independence
   - think then check for conflicts of interests (who/why)
3. Terms of Engagement
   - set out in writing full confirmation of instructions to client prior to starting work and recieve written confirmation of instruction
   - confirm competence of valuer
   - extent and limitations of valuers inspection must be stated

Question 3

Statutory due diligence for valuations

Answer 3

Done to check there are no material matters which could impact the valuation/

1. asbestos register
2. business rates/council tax
3. contamination
4. equality act compliance
5. environmental matters (eg. elec sub-stations, telecoms masts)
6. EPC rating
7. Flooding
8. fire safety compliance
9. h&s compliance
10. highways
11. legal title and tenue (check boundaries, ownership, deeds of covenants. easements)
12. public rights of way (from OS sheet)
13. Planning history and compliance

Question 4

Timeline of a valuation (don’t memorise word for word just think in context of when i have done valuation)

Answer 4

1. receive instruction
2. check competence
3. check independence (no conflict of interest)
4. issue terms of engagement to client and recieve signed version
5. gather info (leases, title docs, planning info, OS plans)
6. undertake due diligence to check no matter which could adversely affect impact upon value
7. inspect and measure
8. research market and assemble, verify and analyse comparables
9. undertake valuation
10. draft report
11. have valuation and report considered by another surveyor for checking purposes
12. finalise and sign report
13. report to client
14. issue invoice
15. ensure valuation file in good order for archive

Question 5

5 Methods of Valuation and 3 Approaches

Answer 5

1. Comparative
2. Investment
3. Profits
4. Residual
5. Contractors (depreciated replacement cost)
   IVS 105 Valuation approaches and methods
6. income approach - converting current and future cash flows into capital value (i.e. investment, residual, profits)
7. cost approach - reference to cost of asset whether by purchase or construction (i.e. DRC)
8. market approached - using comparable evidence available (i.e. comparable method)

Question 6

Comparative method of Valuation Steps

Answer 6

Steps:

1. search and select comps
2. confirm/verify details and analyse headline rent to give net effective rent as appropriate
3. assemble comparables in schedule
4. adjust comparables using hierarchy of evidence
5. analyse comparables to form opinions of value
6. report value and prepare file note

Question 7

Comparable method Hierarchy of Evidence

Answer 7

1. Open arket lettings
2. Lease renewals
3. Rent review
4. Third Party determinations
5. sales and leasebacks
6. inter-company transactions

Question 8

Relevant comparables - comparative method

Answer 8

• importance of accurate and up-to-date market knowledge and timing when findings comps and what makes a good comp
• inspection of area to find recent market activity by seeking agents boards
• speak to local agents
• auction results (beware these are gross prices, and there may be special purchaser or insolvency sale)
• in house records/databases and websites eg EGI and focus
• date of evidence crucial in volatile market conditions

Question 9

Investment method of valuation

Answer 9

• used when there is an income stream to vaue
• rental income is capitalised to produce capital value
• conventional method assumes growth implicit valuation approach
• implicit growth rate is derived from market capitalisation rate (yeild)

Question 10

Investment method of valuation - conventional method

Answer 10

• rent received, or market rent multiplied by the years purchase = market value
• importance of comparables for rent and yield

Question 11

Investment method of valuation - term and reversion

Answer 11

• used for reversionary investments (market rent more than passing rent) i.e. when under-rented
• term capitalised until rent review/lease expiry at an initial yield

Question 12

Layer/hardcore method

Answer 12

• used for over-rented investments (passing rent more than market rent)
• income flow divided horizontally
• bottom slice = market rent
• top slice = rent passing less market rent until next lease event
• higher yield applied to top slice to reflect additional risk
• different yields used depending on comparable investment evidence and relative risk

Question 13

Yields (about)

Answer 13

• a measure of investment return, expressed as a percentage of capital invested
• a yield is calculated by income divided by price x 100
• consider the choice of a yeild adopted- found by comparable evidence
• why different yields for different uses of property
• know current prime and secondary yields for all major use classes
• Years Purcahse calculdted by dividing 100 by the Yeild (this is number of years required for income to repay purchase price)

Question 14

Risk when determining yield

Answer 14

• prospects for rental and capital growth
• quality of location and covenant
• use of property
• lease terms
• obsolescence -what is likely future rate?
• voids - what is the risk?
• security and regularity of income
• liquidity - ease of sale

Question 15

Return - Investment method of valuation

Answer 15

• measured retrospectively

- use a DCF calculation to find internal rate of return

Question 16

Secondary yields - Investment method of valuation

Answer 16

• understand reason for a yielf gap between prime and secondary yields to reflect the risks

Question 17

All growth implicit - Investment method of valuation

Answer 17

• yield adopted assumes many of the assumptions that are made explicity in DCF approach and risks are hidden in selected yield
• need to use comparable method of valuation to decide the yield

Question 18

Yields (definitions)

Answer 18

All risks yield remunerative rate of interest used in valuation of fully let property let at market rent reflecting all prospects and risks attached to particular investment
True yield - assumes rent is paid in advance not arrears (traditional valuation pratcie assumes rent paid in arrears)
Nominal yield - initial yield assuming rent paid in arrears
Gross yield - yield not adjusted for purchasers costs (eg auction result)
Net yield - resulting yield adjusted for purchasers costs
Equivalent yield - average weighted yield when a reversionary property is valued using initial and reversionary yield
Initial yield - simple income yield for current income and current price
Reversionary yield - Market rent divided by current price on an investment let at a rent below market rent
Running yield - the yield at one moment in time

Question 19

Discounted cash flow technique

Answer 19

• growth explicit investment method of valuation
• DCF valutions involves projecting estimated cash flows over an assumed investment holding period, plus an exit value at the end of the period, usually arrived at on ARY basis. Cash flow is then discounted back to present day at a discount rate (knowen as desired rate of return) that reflects percieved level of risk
• used for number of valuations where projected cash flowers are explicitly estimated over a finite period, such as:
• short leasehold interests and properties with income voids or complex tenures
• phased development projects
• some ‘alternative’ investments
• non-standard investments (say with 21 year rent review)
• over-rented properties and social housing
• approach separates out and explicitly identifies growth assumptions rather than incorporating them within an ARY
• RICS published Guidance Note on Discounted cash flow for commercial property investments in 2010 which provides a useful summary of methodology for this technique
  Simple method to find market value
  1. estimate cash flow (income less expenditure)
  2. estimate exit value at end of holding period
  3. select discount rate
  4. discount cash flow at discount rate
  5. value is sum of completed discounted cash flow to provide NPV

Question 20

Net Present Value

Answer 20

• sum of discounted cash flows of the project
• NPV can be used to determine if an investment gives a positive return against a target rate of return
• when NPV is positive, investment has exceeded the investors target rate of return
• when NPV is negative, it has not achieved investors target rate of return

Question 21

Internal rate of Return

Answer 21

• rate of return at which all future cashflows must be discounted to produce a NPV of zero
• IRR used to assess total reutn from investment opportunity making some assumptions regarding rental growth, re-letting and exit assumptions
• if valuer does not have software programme to calculate IRR, linear interpolation can be used to estimate IRR
  to calculate IRR:
  1. input current market value as negative cash flow
  2. input projected rents over holding period as positive value
  3. input project exit value at end of term assumed as positive value
  4. discount rate (IRR) is rate chosen white provide NPV of zero
  5. if NPV more than zero, target rate of return is met

Question 22

Purpose of Profits method

Answer 22

• used for valuations of trade related property, where there is a ‘monopoly’ position
• used where the value of the property depends upon the profitability of its business and its trading potential
• used for pubs, petrol stations, hotels, guest houses, childrens nurseries, leisure and healthcare properties and care homes
• basic principle is that the value of the property depends on the profit generated from the business, not the physical building or location
• must have accurate and audited accounts for 3 years
• audited accounts are superior to management accounts
• use estimate / business plan if needed for a new business
• adjust for maturity of business and any unacceptable or exceptional items of expenditure

Question 23

Profits method

Answer 23

annual turnover
- costs/purchases
= gross profit
- reasonable working expenses
= unadjusted net profit
- operators remuneration
= adjusted net profit known as the Fair Maintainable Operating Profit (FMOP)
can be expressed as EBITDA (earnings before interest, taxation, depreciation and amortisation)
Capitalised at appropraite yield (years purchase multiplier) to achieve market value
Cross check with comparable sales evidence if possible

Question 24

Purpose of residual method of valuation and development appraisals

Answer 24

• development appraisal is a tool to financially assess the viability of a development scheme
• one can be used to establish a residual site value
• they can also be used to assess profitability of a proposed scheme and its sensitivity to changing inputs, or assessing viability of different uses, rents, yields or financial contributions, such as s.106 / CIL payment

Question 25

Development appraisal

Answer 25

• a calculation or series of calculations to establish the value/viability/profitability/suitability of a proposed development bases upon clients inputs
• can assume a site value or calculate site value
• a valuation is one of the possible outputs from the appraisal
• provides guidance as to the visibility of the proposed development

Question 26

Residual site valuation purpose

Answer 26

• most common purposed is for specific valuation of a property holding to find market value of the site based on market inputs
• at one moment in time at the valuation date for a particular purpose
• this is a form of development appraisal
• it can be based upon a simple residual valuation or DCF method
• all inputs are always taken at date of valuation

Question 27

Methodology for Residual Site Valuation

Answer 27

GROSS DEVELOPMENT VALUE
- market value of completed proposed development at todays date/date of valuation
- use plans if needed and measure on CAD
- valued at current date assuming present values and market conditions
- comparable method of valuation used to establish rents and yield
- all risks yield used
- an allowance of a rent-free period or tenant incentives and marketing void can be assumed if appropriate
- purchasers costs are usually deducted for commercial property valuations
TOTAL DEVELOPMENT COSTS
- site preparation: demolition remediation works, landfill tax, provision of services, site clearance, levelling, fencing and provision of services/obtain contractors estimate for these works
- planning costs: town and country planning act 1990 s106 payments (legal agreement for planning obligations eg affordable housing-infrastructure costs-new school etc) to gain a planning consent, local planning policy will set out the required percentage of affordable housing required for a new residential development in the form of social, intermediate and key worker housing, other planning obligations could relate to the provision of open spaces/playgrounds-public art-financial contributions towards local services, planning application and building regulation fees, section 278 works for highway works, cost of planning consultant, cost of environmental impact assessment and/or any other specialist reports required by the local planning authority
- building costs: estimate total building costs, sources of building costs include client info/spons building costs book/quantity surveyor estimate/building surveyor estimate/RICS building costs information service (BCIS) usually on a GIA basis
- professional fees (10-15% plus VAT of total construction costs for professional fees for architect,M&E, project managers, structural engineers - a lower % would be appropriate for a large project), architects are usually the largest proportion of total fees, remember CDM principal designer costs
- contingency (10-15% plus VAT of total construction costs depending on level of risks and likely movements in building costs)
- marketing costs and fees: assume realistic marketing budget, cost of EPC, NHBC warranty for residential schemes, normal sale fee around 1-2% GDV and normal letting fee around 10% of initial annual rent
- calculation of finance: choice of interest can include LIBOR (which is variable lending rate between banks for 3 month borrowing term) plus premium to reflect interest rate which is available- bank of england rate plus premium- rate at which client can borrow money, 3 elements for finance the developer needs to borrow money for 1. site purchase (incl. purchasers costs) compound interest on straight-line basis 2. total construction costs and associated costs (calculation based on an S-curve taking half the costs over the length of the build programme 3. holding costs to cover voids until the disposal of the scheme (empty rates, service charges and interst charges- compound interest on straight-line basis)
- method of calculation: assumes 100% debt finance, finance for borrowing the money to purchase the land is calculated on straightline basis using compound interst over length go the development period, rolled up method of calculation is used (compound interest), to calculate finance required for construction period, assume total construction costs including fees over half of time period using S curve calculation, the principle of s curve is that as payment of construction costs adopts the profile of S shaped curve over length of development projects, usual assumption is to halve the interest that would be borrowed for all of the construction period, purpose of s curve is to reflect accurately when monies drawn down, calculate any finance required for on-going holding costs from completion of construction until disposal on straight line basis using compound interest
DEVELOPERS PROFIT
- percent of GDV or construction cost (15-20% depending on risk), GDV more frequently used as base of resi, if scheme low-risk a lower return may be required, % of profit has recently risen given riskier market conditions, other methods to calculate profit required is to base it on return upon capital employed (ROCE), deduct total development costs of GDV to establish site value having allowed for normal purchasers costs, cross check site value with valuation of comparable site values if poss

Question 28

Development Finance

Answer 28

2 main methods of funding:

1. debt finance (lending money from bank or other funding institution)
2. equity finance (selling shares in a company or joint venture partnership or own money used)
   - loan to value ratio currently in region of 60%
   - interest calculated on rolled up basis i.e. added to loan as project proceeds
   - senior debt is first level of borrowing which takes precedence over secondary/mezzanine funding
   - mezzanine funding is additional funding for additional monies required over normal LTV lending
   - swaps are a form of derivative hedging rate for interest rates
   - swap rate is the market interest rate for fixed rate, fixed term loans
   - other methods of arranging finance include joint ventures (2 or more parties join to develop) or forward sales (where completed scheme pre-sold to either an investor or occupier)

Question 29

Overage

Answer 29

• arrangement made for the sharing of any extra receipts received over and above the profits originally expected as agreed in a pre-agreed formula
• can be shared between the vendor/landowner and developer in a pre-arranged apportionment
• also known as claw back

Question 30

VAT

Answer 30

VAT payable on all professional fees

Question 31

Profit erosion period

Answer 31

• length of time it will take for the development profit to be eroded by holding charges following the completion of the scheme until the profit from the scheme has been completely drawn down, due to interest charges, and the scheme is loss making

Question 32

Limitations of residual valuation methodology and financial modelling

Answer 32

• importance of accurate information and inputs
• a residual valuation does not consider timing of cash flows
• very sensitive to minor adjustments
• implicit assumptions hidden and not explicit (unlike a DCF)
• always cross-check with a comparable site valuation if possible

Question 33

Sensitivity analysis

Answer 33

• required for key variables such as GDV, build costs and the finance rate, to show range of values
  3 FORMS OF SENSITIVITY ANALYSIS
  1. simple sensitivity analysis of key variables such as yield GDV build costs and finance rate
  2. scenario analysis - change scenarios for the development content/timing/costs such as phasing the scheme or modifying the design
  3. monte carlo simulation using porbability theor using software such as crystal ball

Question 34

Reporting development valuation

Answer 34

• comment on costs and contract procurement
• viability of proposed project
• assumptions and sensitivity in residual calculation
• implications of contract/cost over runs
• reflect of market conditions at date of valuation

Question 35

Depreciated Replacement Cost (DRC)

Answer 35

• should only be used where direct market evidence is limited or unavailable for specialised properties
• specialised properties such as lighthouses, schools, docks,
• used for owner occupied property
• for accounts purposes for specialised purposes
• also used for rating valuations of specialist properties

Question 36

Depreciated Replacement Cost (DRC) methodology of valuation

Answer 36

1. value of land in its existing use (assume planning permission exists)
2. add current cost of replacing the building plus fees less a discount for depreciation and obsolescence/deterioration (use BCIS).
   Need to estimate amount of depreciation appriopriate for physical, functional and economic obsolescence:
   - physical obsolescence is result of deterioration/wear and tear over the years
   - functional obsolescence is where design or specification of asset no longer fulfils function for what it was originally designed
   - economic obsolescence is due to changing market conditions for use of asset

Question 37

VPS1

Answer 37

Terms of engagement (IVS 101 Scope of Work)

• assumptions made where reasonable for valuer to accept something is true without need for specific investigation
• a special assumption is supposition that is taken to be true and accepted as fact, even though it is not true
• it must be agreed with client in writing at commencement of instruction, eg. relating to such matters as assuming planning consent has been granted for a particular use or property is vacant or let at date of valuation

Question 38

VPS2

Answer 38

Inspections, Investigations and Records
Inspections:
- valuers must take the steps to verify the necessary information being relied upon for valuatiton to ensure the information is professionally adequate for its purpose
Restricted info (desktop) valuations (no inspection undertaken):
- this red book valuation unless for one of precific purposes set out in PS1
- when valuer is instructed to undertake valuation on basis of restricted info or without physical inspection the valuer should consider four factors:
1. nature of restriction must be agreed in writing in terms of engagement
2. possible valuation implications of restrictions confirmed in writing before value reported
3. valuer should consider if restriction is reasonable with regard to purpose of valuation
4. restriction must be referred to in report
Revalutation (without reinspection):
- revaluation without reinspection of property previously valued must not be undertaken unless the valuer is satisfied that there have been no material changes to the property or nature of its location since last inspection
- this must be confirmed in terms of engagement and in valuation report

Question 39

VPS3

Answer 39

Valuation reports

Question 40

VPS 4

Answer 40

Bases of value, assumptions and special assumptions

Question 41

Rights of Light

Answer 41

• RICS Guidance Note on Rights of Light 2016
• right to light of building of a building arises after twenty years uninterrupted enjoyment of light without consent of 3rd party by way of easement of prescriptive right. if right to light is infringed, an injunction can be granted, or damages awarded
• case law: HKRUK II (CHC) v Heaney 2011, outcome of case left Highcross with remedial works bill and mandatory injunction to reduce scale of extended Toronto Square scheme in Leeds where 2 more floors were added to existing office building

Question 42

Party Walls

Answer 42

• wall is a party wall if it stands astride the boundary of land belonging to 2 or more different land owners
• some surveyors specialise in party wall disputes
• party wall etc act 1996 provides framework for resolving disputes in relation to party walls, boundary walls and excavations near neighbouring buildings. Act provides a building owner, who wishes to carry out various sorts of works to existing party wall, with additional rights going beyond ordinary common law rights. if you are a party wall owner, you must inform all adjoining owners of your intention to undertake any works to party wall