Valuation - KT Qs

Question 1

What are the 5 methods of valuation?

Answer 1

Comparative Method

Investment Method

Profits Method

Residual Method

Depreciated Replacement Cost (DRC)

Question 2

Which methods have you got experience of?

Answer 2

Comparative Method

Investment Method

Question 3

Talk me through (step-by-step) your valuation in Islington?

(They may say - tell me about a valuation instruction end-to-end).

Answer 3

I valued a Freehold office building in Islington, as the client was considering whether the sell the property.

Therefore, it was NOT a Red Book valuation (as this is one of the 5 exemptions).

I assessed my competence (SUK), carried out a Conflict of Interest check and ensured Terms of Engagement were signed and returned.

I then inspected and measured the property, taking note of the buildings location, condition and specification.

As the property was owner-occupied, I used the COMPARATIVE METHOD.

1. I sourced my comparables
2. VERIFIED the details by speaking to relevant agents. This allowed me to devalue the headline rent to get the NET EFFECTIVE RENT.
3. I then created a schedule of comparables
4. Adjusted comps in relation to the HIERARHCY OF EVIDENCE.
5. Analysed to form opinion on Market Rent (MR) and Market Value (MV) .
6. I then stood back & looked. Report the value and saved on file.

Question 4

How else could you have approached it?

Was there enough Freehold VP sales evidence around?

Answer 4

Used the investment method as a cross-check.

Capitalising the income stream to produce a capital value.

Question 5

Describe the property in your Islington example?

Answer 5

1980s construction

15,000 sq ft

Lower Ground to 4th floor

Grade B spec

1 minute walk from Angel tube station

Question 6

You mention the Hierarchy of Evidence - what is this?

Answer 6

Framework for comparables based on weighting:

Category A = DIRECT COMPARABLES

• Data from the subject property itself (the best)
• Completed transactions from near-identical properties.
• Contemporary, full and accurate information.

Category B = GENERAL MARKET DATA

• Published sources / Commercial Databases (e.g. CoStar).
• Historic Evidence
• Supply and Demand data.

Category C = OTHER SOURCES

• Wider market data (interest rates, stock & shares).
• MSCI

Question 7

When using the comparative method, is there any specific guidance you adhere to?

Answer 7

RICS Professional Standard: “Comparable Evidence in Real Estate Valuation” (2019) - now a Professional Standard in 2023.

It specifically outlines the Hierarchy of Evidence.

Question 8

What makes a good comparable?

Answer 8

Huge focus on “Contemporary” in the Hierarchy of Evidence (“Contemporary, full and accurate information”).

The best comparable will be in the subject property itself.

Strong comparable will be an almost identical property, next door to the subject property which transacted yesterday and you have full & accurate information on the deal. Think:

• Contemporary
• Location
• Similarity
• Transparency
• Arms-length, open market transaction

Question 9

How did you find your comparable evidence?

Answer 9

Inspection of the local area to find ‘TO LET’ boards

Speaking with local agents

CoStar / Property databases and VERIFY the information.

Question 10

What would you do when there is a lack of comparable evidence?

(This is a good question)

Answer 10

Have to rely on historical data and ‘quoting prices’

Look down the Hierarchy of Evidence and consider Category B / C evidence such as supply and demand data.

Look to use an alternative valuation method which is less reliant on comparable evidence.

Always consider market sentiment at the time where there is a lack of comparable evidence.

Also consider VPGA 10 “Matters that give rise to Material Uncertainty”.

Question 11

Why was your Valuation at Islington NOT a Redb Book valuation?

Answer 11

Because it was for AGENCY PURPOSES (the client was considering whether to sell the building).

Remember ALIES (Agency, Litigation, Internal purposes, Expert Witness, Statutory purposes).

Question 12

What was the Market Value you arrived at for your Islington example?

Answer 12

£7.5m.

(£500 per sq ft).

Question 13

Tell me some of the main factors that would impact upon an office valuation such as this one?

Answer 13

Location

Size

Condition

Internal Specification

Asset Class

ESG credentials

Question 14

You also valued a multi-tenanted office building in Camden, and you did an approach per tenancy as I understand it, i.e you valued it per floor. What was the Basis of Valuation you used for that please?

Answer 14

Fair Value (because it was for Financial Accounting Purposes).

The International Financial Reporting Standards (IFRS 13) had been adopted by the client.

Question 15

Talk me through your Valuation in Camden (step-by-step)?

Answer 15

I valued a multi-tenanted office building in Camden for Financial Accounting Purposes.

Therefore, the Basis of Value was FAIR VALUE (must say this) as the client had adopted International Financial Reporting Standards (IFRS 13).

Firstly, I assessed my competence (SUK), carried out a Conflict of Interest check and ensured Terms of Engagement were signed and returned.

Then began STATUTORY DUE DILIGENCE checks (to check there were no material matters which could impact upon the value).

Then I inspected & measured the property (taking note of the location, condition and specification).

I then began researching the market for rental and captial comparable evidence.

As the property was let and income producing, I used the Investment Method of valuation.

I applied SPLIT YIELDS to reflect the RISK PROFILE of the current tenants.

The first floor tenant had 7 years unexpired on their lease and a Dun & Bradstreet check showed they were of good quality covenant. Therefore, I applied a yield of 6%.

However, the ground floor tenant had 1 years remaining on the lease and the D&B check was more risky. Therefore, I applied a higher yield of 7% to reflect the risk.

I then provided my supervisor (who was a Reigstered Valuer) with a summary form to review.

Question 16

Was this the conventional investment method?

How did you establish what yields to apply?

Answer 16

Yes because the property was rack-rented. The split yields were to reflect the risk profile.

The yields were arrived at from comparable evidence. Used a Central London yield guide.

Question 17

What yield did you apply?

Answer 17

1st floor tenant = 6%.

Ground floor tenant = 7%. Higher yield to reflect the additional risk.

Question 18

What are the two commonly used financial reporting standards used in the UK?

Answer 18

IFRS (International Financial Reporting Standards); principles-based

UK GAAP (Generally Accepted Accounting Practice in the UK); rules-based

Question 19

What is the definition of Market Value?

Answer 19

Market Value is the estimated amount which a property should EXCHANGE:

• On the valuation date
• Between a willing buyer & a willing seller
• In an arm’s length transaction
• After proper marketing

Where the parties have acted, prudently, knowledgeably and without compulsion.

Question 20

When is Fair Value required?

Answer 20

If the International Financial Reporting Standards (IFRS) have been adopted by the client.

Fair Value is used for valuations for Financial Accounts purposes.

The RICS’ view is that this definition is generally consistent with the definition of the Market Value.

Question 21

What is the definition of Fair Value?

Answer 21

Fair Value = The price that would be recieved to sell an asset in an orderly transaction between market participants at the MEASUREMENT DATE.

Question 22

What is the difference between Market Value and Fair Value?

(CRUCIAL QUESTION)

Answer 22

There is a subtle difference between Market Value and Fair Value - but it’s quite a key one.

The Red Book defines Market Value as:

The estimated amount which an asset or liability should exchange:

• On the valuation date
• Between a willing buyer & a willing seller
• In an arm’s length transaction
• After proper marketing

Whereas Fair Value is:

The price that would be recieved to sell an asset at the MEASUREMENT DATE.

(What this essentially means is Fair Value is the “MUTUALLY BENEFICIAL VALUE” between buyer and seller).

(Whereas Market Value is influenced by market forces).

RICS’ view is that Fair Value is generally consistent with Market Value.

Question 23

So this was a Red Book valuation. What did you include in your Terms of Engagement?

(V Common Question)

Answer 23

Identification & Status of the Valuer (Set out ID and RICS Registered Valuer status).

Identification of the Client (intended user and any other indended users).

Identification of the asset being valued.

Currency (financial) to be used

Purpose of the valuation (This was for Accounts).

Basis of Value (This was Fair Value).

VALUATION DATE

Nature and source of information to be relied upon.

Assumptions & Special Assumptions to be made.

Format of the report.

Confirmation that the valuation will be Red Book compliant/IVS compliant.

The basis on which the fee will be calculated.

Complaints Handling Procedure MUST be made available in ToE.

A statement setting out any limitations on liability.

Question 24

What are the first 5 Terms of Engagement?

Answer 24

Identification and Status of Valuer (Set out ID and RICS Registered Valuer status).

Identification of the Client (intended user and any other intended users).

Identification of the asset to be valued.

Currency (financial)

Purpose of the valuation

Question 25

Why are establishing clear Terms of Engagement so important wen considering a valuation?

Answer 25

ToE are the contractual basis of your relationship with the client and an important defence against negligence claims.

Question 26

What is the purpose of the Red Book?

Answer 26

COT

Purpose = CONSISTENCY, OBJECTIVITY & TRANSPARENCY on a global scale.

Question 27

What were the 2022 updates to the Red Book in a nutshell?

Answer 27

1. Sustainability and ESG factors (the main update to the Red Book).

• Glossary definitions of ESG included.
• For inspections and reporting (VPS2 and VPS3) - valuers should have regard to the relevance of sustainability and ESG factors.
• Language is clearer and more robust towards ESG.

2. Valuation for Financial Reporting Purposes (VPGA 1). References to IFRS 13 and the need to provide Fair Value measurements.
3. Reference to the use of the Profits Method (VPGA 4) for trade-related valuations.

Question 28

When would a valution NOT be Red Book?

(COMMON QUESTION)

Answer 28

(ALIES)

Agency purposes

Litigation / negotiation

Internal purposes

Expert Witness

Statutory purposes

Question 29

How would you value a property that is Over-Rented?

Answer 29

Hardcore Layer Method.

Divided the income stream horizontally.

Bottom Slice = Market Rent.

Top Slice = Passing Rent - Market Rent until the next lease event.

Apply a higher yield to the top slice to reflect additional risk (yield from comparable evidence).

Question 30

What is the UK National Supplement?

Answer 30

Emphasis that the content of the natinonal supplement is SUPPLEMENTARY to the Red Book and is no substitution to it.

It supplements the Red Book for valuations that are subject to UK jurisdiction.

(“The Extra Bit”).

Question 31

When would you use the Profits Method?

Answer 31

Used for TRADE-RELATED property.

When the value of the property depends upon the PROFITABILITY of the business and trading potential (rather than the property or location).

E.g. pubs, hotels, petrol stations, leisure, care homes.

Question 32

What are the steps in the Profits Method?

Answer 32

Basic principle is the value depends on PROFIT generated from the business (not the physical building).

Get the past 3 years’ audited accounts.

Establish Fair Maintainable Operating Profit (FMOP) by deducting all costs/expenses to get the net profit.

EBITDA (Earnings before Interest, Tax, Depreciation, Amortisation) capitalised at an appropriate yield to find Market Value.

(Cross check with comparable sales evidence if possible).

Question 33

Tell me some of the main factors that would impact upon a valuation of say an office?

Answer 33

Location

Size

Age

Condition

Internal Specification

Existing lease terms.

Question 34

What Statutory Due Diligence enquiries did you carry out in your example?

Answer 34

Asbestos Register

Business Rates

Contamination

Equality Act (2010) compliance

Environmental Matters (high voltage power lines, telecoms masts etc)

EPC rating

Flooding Risk (check Environmental Agency)

Health & Safety compliance

Fire Safety compliance

Legal title + Tenure (check the boundaries / ownership, Land Registry)

Planning History (e.g. check is conservation area / check if Listed).

Question 35

With your Camden example, you say one tenant only had a year remaining on the lease. How would you value this afterwards?

Answer 35

I would use an EQUIVALENT YIELD which factored in the void period.

Question 36

What’s topical with valuations at the moment - anything you have seen in the news?

(HOT TOPIC)

Answer 36

RICS introduced MANDATORY ROTATION RULES for Valuers.

Firms cannot value an asset for more than 10 years.

This was in response to Peter Pereira Gray’s independent review of investment valuations.

Question 37

What is an accounts valuation and how does it differ from the investment method?

Answer 37

An accounts valuation is carried out on the basis of fair value (IFRS 13).

Fair Value = the price that would be recieved to sell an asset in an orderly transaction at the MEASUREMENT DATE.

Question 38

When is an accounts valuation needed?

Answer 38

When the IFRS have been adopted by the client.

Question 39

When would you use an Equivalent Yield?

Answer 39

When there is a level of vacancy in the building.

You would use comparables to assess this.

Equivalent Yield = the average weighted yield when a reversionary property is valued using an initial and reversionary yield.

Question 40

You say the property in Camden was rack rented, what did that mean for your valuation?

Answer 40

Let at the current market rent.

Horizontal line graph. I also used a net initial yield to capitalize the rent.