Valuation - L1 extra Flashcards
Valuation L1 knowledge
RICS Valuation - Global Standards (Red Book)
x2 Red Books
- RICS Valuation - Global Standards (Red Book, effective 2022)
–> Greater emphasis on sustainability - The Red Book UK National Supplement was published on 19 October 2023 and will become effective 1 May 2024.
The relationship between Global Red Book and the UK national supplement
The UK national supplement supports the Global Red Book for valuations that are subject to UK jurisdiction but does not replace them.
The new UK supplement update addresses recommendations found in the Independent Review of Real Estate Investment Valuations, published in January 2022.
What is the New Red Book UK National Supplement advice on rotation rules
The new rules will prevent valuation firms from valuing an asset for regulated purposes for more than ten consecutive years, requiring a change or “rotation” to a different valuation firm.
These critical changes will improve transparency, ultimately serving the public interest.
When should it not be a Red Book valuation
- Statutory purposes
- Agency
- Internal
- Expert witness
- Litigation / Negotiation
Three steps before undertaking valuation
Competence
–> Are you com to undertake this instruction. Correct skills, understanding and knowledge. (Good knowledge of the area.)
Independence
–> Think first then check for conflict of interests
Terms of Engagement
–> Set out in writing your full confirmation of instructions to the client prior to starting work and receive written confirmation of instruction
–> Confirm the competency of the valuer
–> The extent and limitation of the valuer’s inspection must be stated i.e. limited access to roof
Due Diligence. Why?
Required to check that there are no material matters which could impact upon the value
Examples of DD
- Asbestos Register
- Business rates/ council tac
- Cntamination
Equality Act 21010 complience
- Envir matters (high voltage power lines, masts)
- EPC rating is avaiable/ applicable
- Flooding (check envir agency website)
- Fire Safety compliance
- Health and Safety compliance
- Highways
- Legal title and tenure
- Planning History
Timeline of valuation instruction
- Receive instruction from the client
- Check Competence (SUK)
- Check Independence - conflict of interest)
- Issue terms of engagement to the client, signed.
- Gather information - leases and DD (EPC) to check there are not matters that could adversely impact upon value
- Inspect and measure
- Research and assembly/analyse comps
- Undertake valuation and draft report
- Get another surveyor to check it.
10 Finalise and sign report, report to client, issue invoice, ensure filed in good order
5 Methods of Valuation
Comparable Method
- comparative
Investment Method
- T&R (under)
- Layer and hardcore (over)
- DCF (long period of time)
Residual Method
- Development
Profits
Depreciate replacement cost
- Contractors method
3 Valuation approaches (as per IVS 105 Valuation approaches and method)
Income Approach - converting current and future CF into capital value e.g. investment, residual, profit
Cost approach - reference to the cost f the asset whether by purchase or construction (DCR)
Market approach - using comparable evidence available - comparable method
Comparable Method Professional Standard
Comparable evidence in real estate valuation (1st edition)
This document was reissued in April 2023 as a professional standard.
(It was previously published in October 2019 as a professional statement.)
Comparable method - 6 steps
- Search and select comps
- confirm details and analyse headline rent to give a net effective rent
- Assemble comparable in schedule
- Adjust comparable using hierarchy of evidence
- Analyse comp to form an opinion of value
- Report value and prepare file note
RICS Professional Standard Comparable evidence in real estate valuation (1st edition) 2019 - reissued as Professional Standard in April 2023
Provides guidance/advice in dealing with situations where there is limited availability if evidence .
Sets a hierarchy of evidence noting the valuer should use personal judgement to assess evidence
Hierarchy of evidence
The relative weight attached to different types of evidence
▪ Cat A - direct comp, near identical. Similar to subject property
▪ Cat B - General market data that can provide guidance e.g. historic data i.e. Barking retail unit
▪ Cat C - Other sources - using other types and locations
How to find rel comparables
- Inspection of an area to find recent market activity
- local agents
- The date of evidence is crucial
- In House records/ databases and websites such as Focus, Egi, Co-Star, Qube/Coyote
Investment Method
Used when there is an income stream to value
The rental income is capitalise d to produced a capital value.
Conventional investment method
Rent received or market rent X YP = Market Value
(using comparables to get the rent and yield)
Term and reversion method
If property is under rented where the market rent is more than the passing rent
Term capitalised until the next review/leave expiry at an initial yield
Reversion to market rent valued in perpetuity at a reversionary yield
Layer and Hardcore method
Used for over rented investments where the passing rent is more than the market rent
Income flow divided horizontally
Bottom slice = is market rent
Top slice = Rent passing less market rent until next lease event
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.
NO PV of £1 needed as both layers of income are being received NOW.
Discounted cash flow (DCF)
Involves projecting estimated cash flows over an assumed investment holding period
Plus an exit value at the end of that period.
The cash flow is then discounted back to present day at the discount rate (aka IRR) that reflects the perceived level of risk
DCF process
- Estimate the cash flow (income less expenditure)
- Estimate the exit value at the end of the holding period
- select the discount rate
- Discount the cash flow at discount rate
- The value is the sum of the completed discounted cash flow to provide the NPV (net present value)
Net present value
The sum of the DCF of the project
Can be used to determine of an investment gives a positive return against the target rate of return
If NPV is positive then the investment has exceeded the investor’s TRR
When the NPV is negative, it has not achieved the TRR
Internal rate of return
The rate of return at which all future CF must be discounted to produce a NPV of zero
Used to assess the total return from an investment opportunity
(If the NPV is more than zero then the TRR is met)
RICS guidance on DCF
RICS Guidance Note on Discounted Cash Flow for commercial property investment 2010
Yields
What is a yield…
▪ Annual rate of return of investment expressed as a %.
▪ Relationship between income and capital value.
▪ A yield comprises ‘Risk free rate + risk (taking into account anticipated rental growth)
Examples of risk are as follows:
‒ Tenant risk – covenant strength
‒ Sector risk
‒ Structural risk – split ownership
‒ Legislations risk (e.g. upwards and downwards rent reviews)
‒ Planning risk – development
‒ Legal risk – tenure/restrictive covenants
PV = Present Value
▪ Present Value is the current worth of a future sum of money.
Market Value definition
Market Value
The estimated amount for which an asset or
liability should exchange on the valuation date
between a willing buyer and a willing seller
in an arm’s length transaction,
after proper marketing
and where the parties had each acted
knowledgeably, prudently and without
compulsion.
Market Rent definition
Market Rent
The estimated amount for which an interest in
real property should be leased
on the valuation date between a willing lessor and a willing lessee
on appropriate lease terms
in an arm’s length transaction,
after proper marketing
and where the parties had each acted knowledgeably, prudently and without
compulsion.
Fair Value
Fair Value
The price that would be received to sell an
asset, or paid to transfer a liability in an
orderly transaction between market
participants at the measurement date.
Calculated the same as Market Value, used
for Regulatory Valuations.
Investment Value (Worth)
Investment Value (Worth)
The value of an asset to a particular owner or
prospective owner for individual investment or
operational objectives.
Profit Method
Profits Method
Used for valuations of trade related property.
Used where the value of the property depends upon the profitability of its business
Examples –> i.e pubs, petrol stations, hotels, self storage, health care.
It is used when the physical buildings are normally only sold as part of a business and typically when the buildings are
constructed solely for that type of business and could only be used for an alternative business after substantial alterations.
Methodology:
- Analyse the accounts/annual turnover (EBITDA)
- Assess the potential gross profit/sustainable
earnings that the property will make - Deduct costs to give estimated profit (FMOP)
- Capitalise profit at an appropriate yield or
multiple with reference to comparable
The Depreciated Replacement Cost Method
Known as the Contractor’s method
Used for specialised assets that are rarely, if ever, traded on the open market, limited/unavailable comparable available
Specialist properties include lighthouse, sewage works, oil refineries, schools, hospitals
RICS definition of DRC
RICS definition:
“The current cost of replacing an asset with its modern equivalent asset less
deductions for physical deterioration and all relevant forms of obsolescence and
optimisation.”
RICS Guidance Note on Depreciated replacement cost
RICS Guidance Note on Depreciated replacement cost method of valuation for financial reporting (November 2018)
DCR Methodology
1a. Calculate the cost of constructing a replica/simple substitute building (the modern equivalent asset - MEA)
1b. Depreciate the cost of the MEA to reflect the current asset
- Calculate the cost or value of an equivalent parcel of land
- Add the two values together
Residual Method
–> used to calculate the Land Value
Establish the value of land on the valuation date using current market assumptions
It is the amount a developer SHOULD be prepared to pay for a site
Development Appraisal
▪ Establish the viability / profitability of a development from a known land value
Provides guidance as to the viability of the proposed development
Difference between a residual and a development appraisal
Development appraisals have a role within the valuation of development sites, but it should be remembered they are two different activities
Calculating Land Value (Residual Appraisal)
GDV (Gross or Net Development Value)
LESS DEVELOPERS PROFIT
–> Calculated as either a % on development costs (including acquisition of the land, fees and finance) or as a % of the GDV or NDV
LESS TOTAL DEVELOPMENT COST
–> professional fees, demolition, Build costs, planning fees, contingency
EQUALS LAND VALUE (‘Residual Lane Value’ (RLV)
Land value
Known as the ‘Residual Lane Value’ (RLV) being what is left from the value of the scheme less total development costs.
It is the amount a developer SHOULD be prepared to pay for a site
Calculating Development Appraisal
Calculating Profit – where we know the cost of the land already
–> GDV - DEV COST = PEV PROFITS
Establish the viability / profitability of a development from a known land value
Gross or Net Development Value
(* Value of completed development)
Less total development costs
(* Build costs, planning & professional fees, demolition and contingency)
Equals DEVELOPERS PROFIT
Red Book
–> RICS Valuation Global Standards (Red Book) effective 2022
- Intro
- Glossary
- Professional Standards (PS)
- (VPS) –> Valuation technical and performance standards
5.Valuation Application (VPGA)
- The International Valuation Standards (IVS)
Structure
PS: MANDATORY for all members providing written valuations
–> No departure is permitted from PS 1 or PS 2 which are mandatory in all circumstances
VPS: MANDATORY in relation to the process of
providing a valuation that is IVS compliant
VPGAs: ADVISORY and embody best practice to
meet a high standard of professional competence
Changes
–> RICS Valuation Global Standards (Red Book) effective 2022
Main changes relating to Sustainability and ESG
–> In inspection and reporting (VPS 2 & 3) valuers should have regard to the relevance and significance of ESG & sus factors which should form part of the approach and reasoning
–> Definition in the glossary - interpretation of ESG & sus are provided as they relate to assets, noting that resilience is replacing sustainability in some instances
VPGA 2 Secured lending- The market influence of ESG and Sustainability, should be considered as part of
the valuation assignment. Additional comments in the report should now include potential future costs to meet
investor and regulatory requirements, relating to sustainability and ESG.
VPGA 8 Valuation of real property interests - This guidance note It expressly covers inspections and
investigations, and includes important material on Sustainability and ESG issues, which can be a market
influence in relation to real estate.
The new book also makes reference to the profits method for certain property valuation i.e. student housing, self storage etc
Purpose of the Red Book
Ensures that valuations are undertaken in compliance with the highest professional standards and assures users that the valuation is:
Independent,
Objective,
Consistent
with standards set by the International Valuation Standards Council
Red Book - Highest professional standards
the Red Book doesn’t tell you how to
value but ensures that valuations are undertaken in compliance with the highest professional standards and assures users that the valuation is independent, objective and consistent.
Benefits of the Red Book
▪ consistency in approach
▪ credible and consistent valuation opinions by suitably trained valuers
▪ independence, objectivity and transparency
▪ clarity regarding terms of engagement (scope of work)
▪ clarity regarding the basis of value, including any assumptions
▪ clarity in reporting
▪ It does not tell you how to value!
PS 1 - Compliance with standards and Practice Statements
Mandatory worldwide (Professional standards)
PS 1 - Compliance with standards and Practice Statements where a written valuation is provided
Mandatory use for all valuation expect for the following 5 exceptions:
- Statutory function
- Litigation and negotiation
- Internal purposes
- Expert Witness
- Agency
SLIEA
PS 2 Ethics, competency, objectivity and disclosures
PS: mandatory for all members providing written
valuations
All members practicing as valuers must have the Appropriate Experience, Skill and Judgement
–> Valuers must act in accordance with the Rules of Conduct
▪ Must always act in a professional and ethical manner free from any undue influence, bias or
conflict of interest. –> detail advice on COI provided.
▪ Members are required to exercise independence and objectivity in all instructions. Not be influenced by any situation which could threaten professional objectivity
–> should apply professional scepticism when reviewing information and data before relying on it
When the valuer has previously valued, disclosures are required in terms of engagement and report, of:
‒ the relationship with the client and previous involvement;
‒ rotation policy;
‒ time as signatory; and
‒ proportion of fees.
Red Book
VPS 1 Terms of Engagement – Client and valuer identity, date, property identity, purpose etc.
VPS 2 – Inspections, investigations, and records – valuer must disclose in TOE if it is (desk top) or restricted.
VPS 3 – Valuation Reports – basis of value, date, valuer, client, purpose.
VPS 4 – Bases of value, assumptions, and special assumptions – MV, MR, Fair Value (price that would be received to sell an asset), Investment Value
VPS 5 – Valuation Approaches and Methods.
VPS 1 Terms of engagement (scope of work)
Must be in writing and must comply with VPS 1.
Terms reflecting IVS 101 Scope of Work:
(a) Identification and status of the valuer
(b) Identification of the client(s)
(c) Identification of any other intended users
(d) Identification of the asset(s) or liability(ies) being valued
(e) Valuation (financial) currency
(f) Purpose of the valuation
(g) Basis(es) of value adopted
(h) Valuation date
(i) Nature and extent of the valuer’s work – including investigations – and any limitations thereon
(j) Nature and source(s) of information upon which the valuer will rely
(k) All assumptions and special assumptions to be made
(l) Format of the report
(m) Restrictions on use, distribution and publication of the report
(n) Confirmation that the valuation will be undertaken in accordance with the IVS
(o) The basis on which the fee will be calculated
(p) Where the firm is registered for regulation by RICS, rm’s complaints handling procedure, with a
copy available on request
(q) A statement that compliance with these standards may be subject to monitoring under RICS’ conduct and disciplinary regulations
(r) A statement setting out any limitations on liability that have been agreed.
VPS 1 Minimum terms of engagement
All assumptions and special assumptions that are to be made in the conduct and reporting of the
valuation assignment must be identified and recorded
▪ Assumptions:
-‒ matters that are reasonable to accept as fact in the context of the valuation assignment without specific investigation or verification. They are matters that, once stated, are to be accepted in understanding the valuation or other advice provided
▪ Special assumption:
‒- an assumption that either assumes facts that differ from the actual facts existing at the valuation date or that would not be made by a typical market participant in a transaction on the valuation date
Only assumptions and special assumptions that are reasonable and relevant having regard to the purpose for
which the valuation assignment is required should be made.
VPS 2 Inspections, investigations and records
▪ Inspections - valuers must take steps to verify the necessary information being relied upon for a valuation to ensure this information is professionally adequate
▪ Revaluation without re-inspection of real property previously valued – ensure no material changes
▪ Valuation records must be kept - noting the importance given to ESG & sus
VPS 3 Valuation reports
The report must clearly and accurately set out the conclusions of the valuation in a manner that is not ambiguous or misleading, and which does not create a false impression.
It must deal with all the matters agreed between the client and the valuer in the terms of engagement
VPS 3 Valuation reports
(Reports matters agreed in the terms of engagement)
IVS 103 Reporting sets out a list of IVS requirements (IVS 103 Reporting):
(a) Identification and status of the valuer
(b) Identification of the client and any other intended users
(c) Purpose of the valuation
(d) Identification of the asset(s) or liability(ies) to be valued
(e) Basis(es) of value adopted
(f) Valuation date
(g) Extent of investigation
(h) Nature and source(s) of the information relied upon
(i) Assumptions and special assumptions
(j) Restrictions on use, distribution and publication of the report
(k) Confirmation that the valuation has been undertaken in accordance with the IVS
(l) Valuation approach and reasoning
(m) Amount of the valuation or valuations
(n) Date of the valuation report
(o) Commentary on any material uncertainty in relation to the valuation
(p) A statement setting out any limitations on liability that have
been agreed.
VPS 4 Bases of value, assumptions and special assumptions
Market Value, Market Rent, Fair Value, Investment Value
The valuer must determine the basis of value that is appropriate for every valuation
Market value
The estimated amount for which an asset or liability should exchange
on the valuation date between a
willing buyer and a willing seller
in an arm’s length transaction,
after proper marketing and
where the parties had each acted knowledgeably, prudently and without compulsion.
Market Rent
The estimated amount for which an interest in real property should be leased
on the valuation date
between a willing lessor and a willing lessee
on appropriate lease terms
in an arm’s length transaction,
after proper marketing
and where the parties had each acted knowledgeably, prudently and without compulsion.
Fair Value
The price that would be received to sell an asset, or paid to transfer a liability
in an orderly transaction
between market participants
at the measurement date.
Investment value (worth)
The value of an asset to a particular owner or
prospective owner for individual investment or
operational objectives.
VPS 5 Valuation approaches and methods
Approaches adopted must always have regard to:
▪ The nature of the asset (or liability)
▪ The purpose, intended use and context of the particular assignment and
▪ Any statutory or other mandatory requirements applicable in the jurisdiction concerned. Valuers should also have regard to recognised best practice within the valuation discipline or specialist area in which they practice
VPS 5 Valuation approaches and methods
Valuers are responsibility for choosing and justifying their val approaches and use of model
(A new VPS in the 2017 edition)
VPGAs
▪ VPGA 1 Valuation for inclusion in financial statements
▪ VPGA 2 Valuation of interests for secured lending
▪ VPGA 3 Valuation of businesses and business interests
▪ VPGA 4 Valuation of individual trade related properties
▪ VPGA 5 Valuation of plant and equipment
▪ VPGA 6 Valuation of intangible assets
▪ VPGA 7 Valuation of personal property, including arts and antiques
▪ VPGA 8 Valuation of real property interests
▪ VPGA 9 Identification of portfolios, collections and groups of properties
▪ VPGA 10 Matters that may give rise to material valuation uncertainty
International Valuation Standards - (IVS)
RICS have updated the Global Valuation Standards (Red Book) to incorporate the changes to the IVS’s, effective on 31st January 2022.
The International Valuation Standards (IVS) form the key guidance for valuation professionals globally and underpin consistency, transparency and confidence in valuations.
The IVS are standards for undertaking valuation using recognised concepts and principles that promote transparency and consistency in valuation practice.
The International Valuation Standards Council (IVSC) promotes leading practice approaches to ensure the conduct and competence of professional valuers.
The Red Book – UK National Supplement
UPDATED 19/10/2023
The Red Book UK National Supplement was published on 19 October 2023 and will become effective 1 May 2024.
(Previously published in 2018, effective 2019)
Contains 18 VPGA (val practice guidance application) - grouping many to be more user friendly
Makes clear that the UK National Supplement augments the Red Book which are subject to UK jurisdiction
The relationship between Global Red Book and the UK national supplement
The UK national supplement supports the Global Red Book for valuations that are subject to UK jurisdiction but does not replace them.
It is not a substitution for the Red Book but provides mandatory statements and advice for UK valuations
Global Red Book and the UK national supplement
The UK version clarifies that the UK version augments the Global Red Book requirements for valuations in the UK and is not a substitute for it
augments -= adds to/ makes it better.
Margin of Error for valuations
Generally, case law precedent refers to a margin of between 10% and 15% depending upon the facts.
(It is has been left to the courts to decide what is a permitted margin of error when carrying out a valuation of property)
Margin of Error for valuations (case law)
- K/S Lincoln and others VS CB Richards Ellis (2010)
K/S Lincoln and others VS CB Richards Ellis (2010)
- The principle of a 10% margin of error was reinforced in this ^ case when valuing 4 hotels in 2005
- Judge stated for commercial +/- 10%but if there are exception features of the property it could be +/- 15%
Margin of Error for valuations (case law)
- Singer & Friedlander Ltd vs J.D Wood (1977)
Singer & Friedlander Ltd vs J.D Wood (1977)
- the usual margin of error can be varied. Narrower for straightforward/easy valuations but Wider for more complex valuations
–> states that the margin of error can be 10% either side of a figure that can be said to be the right figure that a competent careful and experienced valuer arrives at after making all the necessary enquiries and paying property regard to the state of the market.
Stamp Duty Land Tax (Stamp Duty)
You must pay Stamp Duty Land Tax (SDLT) if you buy a property or land over a certain price in England. Depends on the price of the land or property
For commercial:
= £0 - £150,000 = £0 - don’t pay pay tax
= £150,001 – £250,000 = pay 2% in tax
= Over £250,001 - pay 5%
Purchasers’ Costs
Usually deduct PC from the market value to provide the net market value as purchaser has to pay these costs:
SDLT - at the prevailing rate - 5% = (depending on the price of the property or land, typically 5% in commercial RE)
Agents Fees - say 1% of the purchasers price plus VAT
Legal/ Solicitor’s fees - 0.5% of the purchaser’s price plus VAT
WAULT (Weighted average unexpired lease term)
Weighted average unexpired lease term remaining to the first break or expiry of a lease across assets weighted by the contract rent
This is a metric used in valuation to assess the weighted average number of years remaining on leases across all properties in a portfolio.
Cal done when valuing an asset or considering appropriate investment yield comparable fir multi- occupied investments/portfolios
How to calculate WAULT
- Add up all contracted income in scheme between now and the break/expiry then divide it by contracted annual rent. Result is expressed as number of years
Zoning
A valuation technique, not a method of valuation ( Zoning is NOT a method of measurement )
Rationale - the rental value of the property reduces away from the street - front section of the shop is most valuable
Zoning is traditionally used for valuing retail property, specifically high street units where the retail frontage is particularly valuable.
Halving back principle with 6.1 meters or 20 foot zones
Zoning is not typically used for larger retail units as it would skew the zoned analysis
RICS Valuer Registration Scheme (VRS)
The RICS introduced a regulatory monitoring scheme for all valuers carrying out Red Book Global valuation from Oct 2011. Registration not mandatory for valuation work excluded from Red Book - i.e. internal purposes
Aims:
- Improve quality of val and ensure highest possible professional standards
- To meet the RICS requirements to self regulate effectively
- To Protect and raise the status of the valuation profession as the leading expert in valuation
