Valuation Basics Flashcards
What are the five methods of valuation
Calculation to derive valuation bases
- Market based:
- Comparable – find comparable evidence
- Investment – capitalise the rental value
- Residual – land value (GDV - development costs – profit = land value)
- Profits – use YP multiplier to capitalise profits
- Non-Market based:
- Depreciated Replacement Cost – current cost of reproduction/replacement
When instructed to do a valuation what steps would you consider?
In accordance with the RICS Valuation Standards
Competence
Independence
Issue TofE - conf of instruct. Competence. Extent and limitations
What are the global basis of value?
Market value Market rent Fair value Investment value (worth) Existing use vale (UK only)
What is the definition of market value?
The estimated amount a property or liability will exchange for on the date of valuation between a willing seller and willing purchaser at an arms length transaction after proper marketing where the parties have acted prudently, willingly and without compulsion.
Take me through the process of a valuation
Firstly I would check my competences, independence and issue ToE.
Signed by client, gather info, due diligence, inspect and measure. RESEARCH MARKET, analyse undertake val. draft report get checked finalise and issue. Send invoice, ensure invoice completed before archiving.
What checks would you do for a valuation? 11
- Asbestos register
- BUSINESS RATES
- Equality act compliance
- ENVIRONMENTAL MATTERS
- Contamination
- Flooding
- Fire strategy compliance
- H&S compliance
- HIGHWAYS
- Legal title and tenure
- Planning history and compliance
What is a valuation?
An opinion of the value of a specified interest in a property on the date if valuation put in writing after an inspection and thorough investigation; unless agreed in ToE not to.
What is worth?
The value a property to an investor (known as investment value)
What is the basis of value?
A statement of the fundamental measurement assumptions on which the reported value is based. Dependent on the purpose of the valuation.
What affects the basis of value?
The nature of the hypothetical transaction
The relationship and motivation of the parties
The purpose of the valuation
What are the different purposes of valuation?
Investment purposes Accounting purposes Loan security purposes Insurance purposes Development purposes
What is market rent?
An estimated amount for which a property will be leased
at the date of valuation
Between a willing lessor and willing lessee
On appropriate lease terms
At an arms length transaction
After proper marketing
Where the parties have acted willingly knowledgeable and without compulsion.
What is fair value?
The estimated price for the transfers of an asset
between identified and knowledgeably parties
that reflects the respective interests of said parties.
What is investment value?
The value of an asset to the owner or prospective owner for individual investment or operational objectives. (Worth).
What is a yield?
A measure of investment return expressed as a percentage of capital invested.
How is a yield calculated?
Income divided be price times 100
= of income was £350,000 pa and the price was £4,500,000 the yield would be
350000/4500000*100= 7.78%
What is a year’s purchase?
The number of years required for an income to pay the purchase price
How is the year’s purchase calculated?
Dividing 100 by the yield. = 100/7.78%= 12.85
What makes a good comparable?
Comprehensive Verifiable Very similar Recent Arms length transaction in open market Consistent with local market practice
What is the principle of comparable evidence?
Underpins valuation as providing the comparables meet the criteria it can provide an accurate indication of value.
What are the three main global approaches to valuation?
Market approach (comparable) Income approach (investment, profits) Cost approach (replacement, residual)
What is the main issue with comparable evidence?
No two properties are identical, lack of transparency affects the use if a comparable.
Therefore the valuer must analyse and interpret available data as a guidance rather than as a direct comparable. SEE RED BOOK GUID NTE 1, REFLECTING UNCERTAINTY IN VALS FOR INVEST PURPOSES.
When would you apply the investment method?
Used when there is an income stream to value. The rental income is capitalised to produce a capital value
When would you apply a term and reversion method?
When the market rent is more than the passing rent.
When would you apply the layer or hardcore method?
When the investment is over rented.
Income flow is divided horizontally.
Bottom slice is market rent
Top slice is rent passing less market rent.
Higher ARY applied to top slice to reflect additional risk
Diff yields used for diff scenarios w rgrd to comp invest evidence.
What is the conventional investment method?
Rent received or market rent multiplied by the years’s purchase to get to market value.
ASSUMES GROWTH IMPLICIT VALUATION APPROACH (ARY applies element of growth)
What is a DCF?
Growth explicit method of valuation. Approach separates out and explicitly identifies growth assumptions rather than incorporating into an ARY.
Uses EQUATED yield
When would you use a growth explicit investment method?
DCF - used where the projected cash flows are explicitly estimated over a finite period…
- Short leasehold interests
- Properties with income voids
- Phased development projects
- Over rented properties
- Investment analysis - assist in buy / sell decision.
What were the changes to the red book?
8th edition 2012….
- Now includes the word Professional
- Definition of fair value rewritten
- Guidance note 7 on DCF removed
- Strengthen rules of dealing with conflict of interests.
Why is the red book necessary?
- Comprehensive set of global val standards
- Achieve high standards of integrity clarity and objectivity adopting val best practice.
- Maintain legal and regulatory compliance
- Sets out core standardised procedures and reporting standards
What valuations and not included in the red book?
- Advice during negotiations
- Statutory valuation purposes i.e taxation
- Internal
- Agency or brokerage work
- Replacement cost figure for insurance
What is contained in Terms of Engagement?
20 MINIMUM - main ones include
- Date of valuation
- Purpose
- Interest to be valued
- Extent of valuers investigations
- Any assumptions
- Compliance with the Red Book
- Fee basis
- Complaints Handling Procedure
What is contained in a valuation report?
20 MINIMUM MATTERS includes Date Purpose Subject Interest Disclosure of material involvement Extent of investigation Signature and date if report
What is zoning?
It’s a valuation technique not a method.
Used for comparison of retail properties to create a unit comparison for different sized buildings.
It is the halving back principles where the rationale is the rental value of a property reduces away from the street.
Zone A rate is the unit of comparison
How would you zone a property?
Measure 6.1m from the front of the store or 9.14 if on regent street. And halve back. Basement and first floor usually treated as A/10 depending on comp.
What is valuation uncertainty?
Market problematic due to lack of comps, valuers must therefore intercept markt conditions. RICS GN1
What advice does the RICS give on uncertainty?
Be transparent in report
Draw attention to any issues affecting uncertainty
Sensitivity analysis provided
What addition matters should be considered for a valuation for secured lending?
Check
Previous involvement past 2 years
Regard to rules of conduct
Conflict of interest
What is contained in a value report if secure lending
20 min requirements plus 13 extra required invade the borrower defaults and bank then owns properly.... 1. Disclosure if any involvement 2. Potential alternative uses 3. Assumptions regarding repair 4. Trends past present future. 5. Method adopted 6. Marketability of the interest 7. Sustainability over life of loan 8. Comparable transactions 9. Suitability of prop for mortgage purposes 10. Any others matters affecting value 11.
What valuations are not covered by the red book?
Agency purposes Negotiations or litigations Internal purposes Stat functions like ratings Insurance valuations
What is covered by her 6 global valuation standards
Ethics Terms of engagement Basis if value Applications Investigations Reporting
What is price?
The actual observable exchange price in an open market
What is value?
The estimated price that would be achieved
What is worth?
The investors perception of the capital sum he is willing to pay for a property.
How would you choose a discount rate?
- Adequate rate of return that compensates investor for risk taken
- A discount rate (hurdle rate / equated yield) reflects the time value of money.
- Should reflect the relative risk of the project and the returns that could be made elsewhere.
- Use the required rate of return for the fund – 7.4%
- Use WACC
- Could take a risk-free rate from 10-year gilts, add on a risk property to reflect the inefficiencies of investing in property and the risk of the particular project
Use CAPM: r = rf b(rm – rf)
R = return
Rf = risk free
Rm = market risk
B = risk
How do you calculate net effective rents for comparables?
Straight line method:
*Does not allow for time value of money
Market practice – 3 month rent free for fit out (UKGN 6 Analysis of Commercial Lease Transactions), remainder as incentive
*Headline rent – divide annual rent by floor area
*Net effective rent – multiply annual rent by term certain. Deduct rent free and capital. Divide by term certain, then by floor area
How do you calculate a net effective rent for a cash flow?
Cash flow basis using ARY:
*Reflects time value of money
*Capitalise rent using yield then PV to include incentives
= annual rent then divide by floor area
How do you calculate a net effective rent on an investment basis?
Investment basis:
- Only apply to investor landlords
- Calculate headline rent into perpetuity deferred by time for incentives
- Net effective into perpetuity must equal capital value above but without incentives
How do you calculate a net effective rent in a DCF?
Discounted cash flow:
- Explicitly stated assumptions
- Tend not to use for simple transactions
What is the hierarchy of evidence?
Relative weight attached to the consideration of comparable evidence
- Open market transactions – market tested
- Lease renewals – market tested
- Rent reviews – market tested
- Third party determinations (expert…arbitrations…court determinations) – not market tested
- Sale and leaseback transactions – not market tested
- Inter-company transactions – not market tested
What is a DCF?
A method of estimating an investment’s current value based on the discounting of projected future revenues and costs.
- Explicitly identifies growth assumptions rather than incorporating into yield
- Uses equated yield/IRR
- Choice of equated yield based on gilt edged stock, additional margin of approx 2% to allow for additional risks/inefficiencies of property
- WACC
What is a ransom strip?
A small strip of land that is retained by a previous owner of the land that can prevent the development of land. The real purpose is, more often than not, to extract payment for its release.
Value usually open to negotiation.
Stokes v Cambridge = a value of 1/3 of the additional development value was awarded.
How would you choose a discount rate?
- Adequate rate of return that compensates investor for risk taken
- A discount rate (hurdle rate / equated yield) reflects the time value of money.
- Should reflect the relative risk of the project and the returns that could be made elsewhere.
- Use the required rate of return for the fund – 7.4%
- Use WACC
- Could take a risk-free rate from 10-year gilts, add on a risk property to reflect the inefficiencies of investing in property and the risk of the particular project
Use CAPM: r = rf b(rm – rf)
R = return
Rf = risk free
Rm = market risk
B = risk
How do you calculate net effective rents for comparables?
Straight line method:
*Does not allow for time value of money
Market practice – 3 month rent free for fit out (UKGN 6 Analysis of Commercial Lease Transactions), remainder as incentive
*Headline rent – divide annual rent by floor area
*Net effective rent – multiply annual rent by term certain. Deduct rent free and capital. Divide by term certain, then by floor area
How do you calculate a net effective rent for a cash flow?
Cash flow basis using ARY:
*Reflects time value of money
*Capitalise rent using yield then PV to include incentives
= annual rent then divide by floor area
How do you calculate a net effective rent on an investment basis?
Investment basis:
- Only apply to investor landlords
- Calculate headline rent into perpetuity deferred by time for incentives
- Net effective into perpetuity must equal capital value above but without incentives
How do you calculate a net effective rent in a DCF?
Discounted cash flow:
- Explicitly stated assumptions
- Tend not to use for simple transactions
What is the hierarchy of evidence?
Relative weight attached to the consideration of comparable evidence
- Open market transactions – market tested
- Lease renewals – market tested
- Rent reviews – market tested
- Third party determinations (expert…arbitrations…court determinations) – not market tested
- Sale and leaseback transactions – not market tested
- Inter-company transactions – not market tested
What is a DCF?
A method of estimating an investment’s current value based on the discounting of projected future revenues and costs.
- Explicitly identifies growth assumptions rather than incorporating into yield
- Uses equated yield/IRR
- Choice of equated yield based on gilt edged stock, additional margin of approx 2% to allow for additional risks/inefficiencies of property
- WACC
What is a ransom strip?
A small strip of land that is retained by a previous owner of the land that can prevent the development of land. The real purpose is, more often than not, to extract payment for its release.
Value usually open to negotiation.
Stokes v Cambridge = a value of 1/3 of the additional development value was awarded.
What is an initial yield?
An income yield, used to value current income and current price
What is an equivalent yield?
Average weighted yield. When a reversionary property is valued using an initial and reversionary yield.
What is a reversionary yield?
Market rent divided by current price on an investment, let at a rent below the market rent.
What is an equated yield?
The average annual overall return an investor requires for the holding period of the investment. A target rate of return.
What is net present value?
The sum of the discounted cash flows of the project
How do you find the market value in a discounted cash flow?
- Estimate the cash flow. 2. Select a discount rate 3. Discount cash flow at the discount rate
- The value is the sum of the completed discounted cash flow to provide the net present value
What is the profits method?
Used for vals of specialist trading properties where there is a monopoly position. E.g pub, petrol station.
Property depends on profitability
What factors must you take into account when valuing property on the profits method?
Maturity of business and any exceptional items of expenditure.
Takes into account profitability of the business not the building or location
Must have 3 years of audited accounts if poss.
How would you value a new specialist property?
Profits method but without accounts hard, can use estimates or business plan if needed for new business.
How do you value an asset using the profits method?
Annual turnover
Minus costs and purchase = gross profit.
Then
Minus work expenses = unadjusted net profit
Then
Capitalised at appropriate yield = capital value
What is the residual method?
To either calculate the profitability of a proposed scheme (dev appraisal) OR to determine the land value (residual)
What is gross development value?
Value once the site is fully developed.
How do you carry at a residual valuation?
Take gross development value
Less total costs, profit and purchasers costs
= site value.
What is the aim of a development appraisal?
To establish the viability or profitability of a proposed development.
What assumptions are made in a development appraisal?
Assumes a site value
Based on today’s values
Does NOT provide a market value
