Valuation - Level 1 Flashcards
What is the Red Book?
The Red Book is a set of global standards which set out procedural rules and guidance for written valautions
What is the Red Book NOT?
The Red Book is not a valuation manual. Global Standards do not:
- instruct members on how to value in individual cases
- prescribe a particular format for reports
- Override standards specific to, and mandatory within, individual jurisdictions
When was the Red Book published?
With Effect - 31 January 2022
What Sections are there in the Red Book?
- Professional Standards - PS 1&2
- Valuation Technical and Performance Standards (VPS) - 1-5
- Valuation Practice Guidance Applications (VPGA)
- International Valuation Standards (IVS)
What is the RICS Guidance to Valuation?
RICS Global Standards 2022
What are the 2022 update all about in nutshell?
One could term this edition ‘the ESG issue’. Sustainability and ESG are the driver behind most of the updates in substance and style and tone. Language is clearer and more robust throughout
What is the purpose of the Reb Book?
prupose = consistency, objectivity and transparency (COT)
What are the exceptions to Red Book?
- Statutory Basis - where carried out by statutory officer
- Negotiation or Litigation - e.g. rent review Litigation
- Internal purposes only
- Agency
- Expert witness valuation
Agency, Litigation, Internal, Expert Witness, Statutory (ALIES)
What are the purpose of valuation?
- Loan Security
- Rating
- Accounts
- Landlord and Tenant
- Tax - Inheritance Tax
- Corporate real estate advice - relocate/refurbish etc.
what is PS 1 & 2?
PS 1 = Compliance with standards where a written valaution is provided
PS 2 = Ethics, competency, objectivity and disclosures
What would you find the Terms of Engagement?
- Identification and status of the valuer
- Identification of the client(s)
- Identification of any other intended users
- identification of the asset(s) or liability(ies) being valued
- Valuation (financial) currency
- Purpose of valuation
- Basis(es) of value adopted
- Valuation date
- Nature and extent of the valuer’s work - including investigations - and any limitations thereon
- Nature of source(s) of information upon which the valuer will rely
- all assumptions and special assumptions to be made
- format of the report
- restrictions on use, distribution and publication of the report
- Confirmation that the valuation will be undertaken in accordance with the IVS
- the basis on which the fee will be calculated
- where the firm is registered for regulation by the RICS, reference to the firm’s complaints handling procedure, with confirmation that a copy will be made available on request
- a statement that compliance with these standards may be subject to monitoring under the RICS’ conduct and disciplinary regulations
- a statement setting out any limitations on liability that have been agreed
What is VPS 1-5?
1 - Terms of Engagement
2 - Inspection, Investigation and recording
3 - Valuation Report
4 - Basis of Value, assumptions and special assumptions
5 - Method of valuation
What are the 6 parts of the Red Book
- Introduction
- Glossary of terms
- Profesional Statements
- Valuation technical and performance standards (VPS)
- Valuation Practive Guidance Application (VPGA)
- International Valuation Standards (IVS)
VPS 3 - what is the minimum headings?
- Identification and Status of valuer
- Identification of client and other intended users
- Purpose of valuation
- Identification of assets
- Basis of value adopted
- Valuation date
- Extent of investigation
- Nature and sources of information relied upon
- Assumptions and special assumptions
- Restrictions on use, distribution of the report
- Confirmation valuation undertaken in accordance with IVS
- Valuation approach and reasoning
- Amount of the valuation
- Date of the valuation report
- Commentary of any material uncertainty
- Statement setting out any limitations on liability that have been agreed
What is the Red Book definition of Market Value and where is it found?
The estimate amount of which an asset or liability should exchange on the valuation date between a willing buyer and willing purchaser in an arm’s length transaction where proper marketing has taken place and both parties acted knowledgably, prudently and without compulsion.
IVS 104. Paragraph 30.1
What is the Red Book definition of Market Rent and where is it found?
The estimated amount which an interest in real property should be leased on the valaution 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 knowledgably, prudently and without compulsion.
IVS 104. Paragraph 40.1
What is the Red Book definition of Fair Value and where is it found? When is it used?
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 (this definition derives from International Financial Reporting Standards IFRS 13). For most practical purposes the concept of fair value is consistent with that of market value, and so there would ordinarily be on difference between them in terms of the valuation figure reported.
Financial Reporting Purposes
What is the Red Book definition of Investment Value and where is it found?
The value of an asset to a particular owner or prospective owner for individual investment or operational objectives.
As the definition implies, and in contrast to market value, this basis of value does not envisage a hypothetical transaction but is a measure of the value of the benefits of ownership to the current owner or to a prospective owner, recognising that these may differ from those of a typical market participant. It is often used to measure performance of an asset against an owner’s own investment criteria.
IVS 104. Paragraph 60.1
What are assumptions?
Assumptions are made where it is reasonable for the valuer to accept that something is true without the need for specific investigation or verification. Any such assumption must be reasonable and relevant having regard to the purpose for which the valuation is required.
What are special assumptions?
Special assumptions are made by the valuer where an assumption either assumes facts that differ from those existing at the valaution date or that would not be made by a typical market participant in a transaction on that valuation date.
What is the Red Book definition of Synergistic Value and where is it found?
Synergistic value is not defined in Valuation Practice Statement 4. it is defined in the International Valuation Standards 2022 - IVS 104
Synergistic value is the result of a combination of two or more assets or interests where the combined value is more than the sum of the seperate values. If the synergies are only available to one specific buyer, then synergistic value will differ from market value, as the synergistic value will reflect particular attributes of an asset that are only of value to a specific purchaser. The added value above the aggregate of the respective interests is often referred to as “marriage value”
what is the market approach
comparing the subject asset with identical or similar assets, for which price information is available, such as market transactions
Comparable method
What is a 3 approaches of valuation
Market Approach
Income Approach
Cost Approach
What is the Income approach?
capitalisation or conversion or present and predicted income.
Investment method
profits method
What is the cost approach?
Provides an indication of value using the economic principle that a buyer will pay no more for an asset than the cost to obtain an asset if equal utility, whether by purchase or by construction.
Residual Method
Depreciated Replacement Cost/contractors Method
How many headings for the Terms of Engagement?
18
what are the methods of valuation?
- comparable method
- investment method
- profits method
- residual method
- Depreciated Replacement cost / contractors method (for rating)
what is the comparable method?
Direct comparison with other similar properties at the same point in time.
Adjustment and analysis required to reflect difference – no two properties are the same.
Always the preferred method of valuation, if sufficient evidence if available.
What RICS Document relates to the comparable method?
RICS Global Standard
Comparable Evidence in Real Estate Valuation 2019
What are the steps for the comparable method?
- Search and select comparables
- confirm details and analyse headline rent
- assemble comparables in schedule
- Adjust comparables using hierarchy of evidence
- analyse comparables to form an opinion
- report value and prepare file note
Investment method - what is the Hardcore layer method?
- 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 to depend on comparable investment evidence and relative risk.
What is the hierarchy or evidence?
- new lettings
- lease renewals
- rent reviews
- third party determination
- sale and leaseback
- inter company transactions
What is the investment method?
- Used when there is an income stream to value
- The rental income is capitalised to produce a capital value
- Conventional method assumes growth implicit valuation approach
- An implied growth rate is derived from the market capitalisation rate (yield)
what are the 4 types of investment method
- conventional method
- term and reversion
- Hardcore layer method
- DCF
Investment method - what is the conventional method?
- Rent Received, or market rent multiplied by the years purchase = Market value
- Importance of comparables for rent & yield.
What are the steps of DCF?
1 Estimate the cash flow (Income less Expenditure)
2 Estimate the exit value at the end of the holding period
3 Select the discount Rate
4 Discount Cash Flows at Discount Rate
5 Value is the sum of the completed discounted cash flows to provide the NPV
Investment method - what is the Term and Reversion?
- Used for reversionary investments (market rent more than passing rent), i.e. When under-rented
Steps
1. Capitalise passing rent using YP at a yeild discounted from market rate
2. Capitalise reversion using market rent into perpetuity using a YP from market rate discounted using present value
3. Add together
4. Stand back and look
What are the decap rates?
2.6% for education 4.4% anything else
What is DRC?
Discounted Replacement Cost
- Growth explicit investment method of valuation
- DCF valuation involves projecting estimated cash flows over an assumed investment holding period, plus an exit value at the end of that period, usually arrived at on a conventional All Risk Yield (ARY) basis. The cash flow is then discounted back to the present day at a discount rate (also known as desired rate of return) the reflects the perceived level of risk.
- Used for a number of valuations where the projected cash flows are explicitly estimated over a finite period, such as for:
o Short leasehold interests and properties with income voids or complex tenures
o Phased development projects
o Some ‘alternative’ investments
o Non-Standard investments (say with 21-year rent reviews)
o Over Rented properties and social housing
o The approach separates out and explicitly identifies growth assumptions rather than incorporating them within an ARY
o The RICS published a Guidance Note on ‘Discounted Cash Flow Valuation’ - November 2023
what is a yield?
A yield is a % based on the rate of return of an investment
What RICS Documents are there for DRC?
- Discounted cash flows
- RICS GN DCF in Commercial Valuation
What is the profits method?
- Used when 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.
- 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 if possible for 3 years.
- Audited accounts are superior to management accounts.
- Use estimates/business plan if needed for a new business.
- Adjust for maturity of business and any unacceptable or exceptional items of expenditure
What RICS document is there for profits method?
The Receipts and Expenditure Method of Valuation for Non-Domestic Rating – A Guidance Note
What is the methodology of the profits method?
- Annual Turnover (income received
- LESS Costs/purchases
- =GROSS PROFIT
- LESS reasonable working expenses
- = UNADJUSTED NET PROFIT
- LESS operator’s remunerations
- ADJUSTED NET PROFIT KNOWN AS THE FAIR MAINTAINABLE OPERATING PROFIT (FMOP)
This can be expressed as the EBITDA is the earning before interest, taxation, depreciation, and amortisation.
Capitalisation at approporate yield (years purchase multiplier) to achieve market value.
Cross check with comparable sales evidence if possible.
What do we use Profits method for?
- Pubs
- Petrol stations
- Hotels
- Guest houses
- Children nurseries
- Leisure and health care properties
- Care homes
What is the residual method?
Used to assess the residual land value of a development opportunity
- Estimate the Gross Development Value
- Subtract construction costs – design and build costs, remediation works, contingency fee, professional fees
- Subtract development costs – developer’s profit, finance costs, planning costs
- This provides your residual land value
What RICS document relates to residual method?
RICS Valuation of Development Property – 2019
What is the methodology for the residual method?
Gross Development Value (GDV) (Capital value of completed scheme)
LESS
All costs to develop (including profit)
= Residual Land value
What is the RICS guidance on comparable evidence?
RICS Guidance Note: Comparable Evidence in Real Estate Valuation (2019)
When would you use Depreciation Replacement Cost?
Depreciation Replacement Cost
Used to value specialised properties for internal and rating purposes when there is limited evidence
The method of last resort and should not be used where there are market sales of comparable properties
Depreciation Replacement Cost = The cost of replacing an asset at the valuation date with its modern equivalent asset minus obsolescence
1. Establish an Existing Use Value for the Land
2. Add the cost of replacing building
3. Add any additional fees e.g professional fees
4. Apply an obsolescence discount
How do you decide which valuation method to apply?
You review the nature of the property and the basis of valuation to establish your valuation method.
When and why would you use the Investment method?
Investment Method – Used to value a property with an existing income stream
When and why would you use the Profits Method?
Profits Method – Used to value specialist properties and businesses e.g public house, golf course, petrol station
When and why would you use the Profits Method?
Residual Method – Used to value the development land and establish the residual land value
When and why would you use the Comparable Method?
Comparable Method – Used as the basis for all valuations it is typically used to assess Market Rent or Market Value
When and why would you use the Depreciation Replacement Cost?
Depreciation Replacement Cost – the method of last resort used to value specialised properties for internal and rating purposes when there is limited/no comparable evidence
What factors may impact value?
- Prospects for rental & capital growth
- Quality of location – impacts market rent
- Covenant Strength – impacts a property’s security of income
- Use of the property – some uses are higher value than others
- Lease terms – impacts rental growth (rent review), obligations for - property owner, onerous
- Obsolescence – is the property fit for purpose
- Voids – gaps in income
- Security and regularity of income – impacted by covenant strength
- Liquidity - ease of sale
Why is independence and objectivity important when valuing?
Independence and objectivity is essential to ensure that there are no conflicts of interest when undertaking a valuation.
Members must follow the mandatory requirements set out in RICS Professional Statement on Conflicts of Interest (2018)
What changes were made to the updates in the Red Book?
- Emphasis on clearer terms of engagement
- Outlines a requirement to provide greater commentary on sustainability and wider ESG matters (covered in VGPA 8)
Which sections of the Red Book are mandatory and which are advisory?
Professional Standards (PS) = MANDATORY
Valuation Technical and Performance Standards (VPS) = MANDATORY
Global Valuation Practice Guidance Applications (VPGAs) = ADVISORY
International Valuation Standards (IVS) = MANDATORY
Which do you follow - the latest IVS or the Red Book Global?
You follow the RICS Valuation – Global Standards 2022 as this has incorporated the latest IVS changes
If you follow the Red Book you will be following the IVS
What do VPGAs relate to?
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 art/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 valuation uncertainty
What type of advice does the Red Book cover?
Valuation advice
If you provide preliminary advice / draft valuation report, what should you state in writing to your client?
When providing preliminary advice or a draft valuation report you must state in writing that:
- the opinion is provisional and subject to completion of the final report
- the advice is provided for the client’s internal purposes only and
- any draft is on no account to be published or disclosed.
- If any matters of fundamental importance are not reflected, their omission must be declared
What type of valuations might be relied upon by a third party?
- Secured lending valuations
- Any valuation that expressly outlines this in the terms of engagement
Does the RICS recognise a difference between fair value and market value?
The RICS doesn’t believe there is a difference between fair value and market value. Fair value is working off the assumption that the property/land owner isn’t going to sell. Not influenced by market forces.
What is a net initial yield?
Net Initial Yield - the current annualised rent, net of costs, expressed as a percentage of capital value
What sources of information would you consider when preparing a valuation report?
Transactional Data – information from transactions that have actually taken place in the market
Market Data – market reports from researchers or analysts
Other sources - indexes
What is the hierarchy of evidence?
Set out in the RICS Guidance Note: Comparable Evidence in Real Estate Valuation (2019)
Hierarchy of evidence
Category A – direct comparables - All types of relevant transactional comparable evidence
Category B – general market data - can provide guidance rather than a direct indication of value
Category C – other sources – Other data that may indicate value
If you have previously valued an asset, do you need to make any
additional disclosures and what might they be?
If valuing an asset that you have previously valued you must make the following disclosures in the terms of engagement, in the report, and in any published reference to the valuation:
- the relationship with the client and previous involvement
- rotation policy
- time as signatory
- proportion of fees
What is a rotation policy?
Rotation policy relates to where the RICS member has provided a series of valuations over time; familiarity with either the client or the asset valued could lead to the perception that the member’s independence and objectivity has been compromised
RICS recommends rotating valuers at least every seven years
When might a conflict of interest exist in relation to a valuation
instruction?
- acting for the buyer and the seller of a property or asset in the same transaction
- acting for two or more parties competing for an opportunity
- valuing for a lender where advice is also being provided to the borrower
What does time as signatory refer to?
Time as signatory means how long the RICS member and firm undertaking the valuation have been signatory to valuations for the same purpose and client
What must be included in your terms of engagement / valuation report?
The terms of engagement must set out the following:
Identification – of the valuer, the client, any other intended user
Property – set out the assets and liabilities being valued
Purpose – of the valuation
Basis – of value
Date – of valuation
Nature and Extent – of the valuer’s work
Sources of Information – relied upon
Assumptions and Special Assumptions – that have been made
Fee – basis on which the fee will be calculated
Complaints Handling Procedure
Insurance – any limitations on liability and the PI cover in place
If your firm is too small to have a rotation policy or valuation panel, what else can you do to ensure objectivity?
You can arrange for the valuation to be periodically reviewed at intervals no greater than seven years by another RICS member to demonstrate that objectivity is being maintained
What is a restricted valuation service and can you provide one?
A restricted valuation service is a where there are restrictions on the information available or the nature of the valuation assignment.
A restricted valuation service may be requested by a client because:
- Requirements for a short timescale may limit the ability to inspect the property to verify facts
- the request may be for a valuation based on the output of an automated valuation model
You can provide one if the restriction is reasonable, with regard to the purpose for which the valuation is required
If you believe that it is not possible to provide a valuation even on a restricted basis the valuation should be declined
What is an internal valuer?
A valuer who is in the employ of either the firm that owns the assets, or the accounting firm responsible for preparing the firm’s financial records
Can you revalue a property without inspecting?
You can revalue a property without re-inspecting if the valuer is satisfied that there have been no material changes to the physical attributes of the property, or the nature of its location, since the last assignment
What happens if market conditions change between the valuation date and report date?
If there has been a material change in market conditions, or in the circumstances of a property, asset or portfolio, between the valuation date and the date of report, the valuer should draw attention to this.
Is special value from a special purchaser reflected in MV?
Market Value ignores any price distortions caused by special value (an amount that reflects particular attributes of an asset that are only of value to a special purchaser)
When would you use EUV?
You would use Existing Use Value when undertaking a depreciation replacement cost valuation
What is the definition of EUV?
Existing Use Value – the value of property or land in its’ current form
What is a yield?
Yield - a measurement of future income on an investment. It is generally calculated annually as a percentage, based on the asset’s cost or market value
What is a reversionary yield?
Reversionary Yield - the anticipated yield to which the initial yield will rise (or fall) once the rent reaches the estimated rental value
What is an equivalent yield?
Equivalent Yield - the average weight between your reversionary and net initial yield (assuming rent is paid quarterly in advance)
What is a nominal equivalent yield?
Same as equivalent yield but you are assuming that your rent is paid annually in arrears
What is WAULT?
WAULT – Weighted Average Until Lease Termination when you have multiple tenants in a building and want to know the time until termination
How would you value a property in uncertain market conditions – does the Red Book give any guidance?
VPGA 10 – provides guidance on matters that may give rise to material valuation uncertainty
You would value the property and if appropriate draw attention to, and comment on, any issues affecting the degree of certainty, or uncertainty, of the valuation
What is the difference between a growth explicit and a growth implicit yield?
Growth explicit yield – does not account for rental growth e.g reversionary yield
Growth implicit yield – does account for rental growth e.g All Risks Yield
How would you value an over-rented investment property?
Core and Top Slice Approach - Property is Over Rented
- Workout the market rent and establish what proportion of your current income is over-rented
- Split out the under rented and over-rented income streams
Apply two different yields –> higher yield to the over rented, lower yield to the under rented - Capitalise the under rented into perpetuity (assuming that the property will always be able to achieve the market rent)
- Capitalise the over rented until lease expiry at which point you assume the property will revert to market rent
How would you value an under-rented investment property?
Term and reversion Approach
- Value the rent until lease end capitalising using an all risks yield
- Capitalise the market rent into perpetuity using a reversionary yield
What would you do if comparable evidence was limited?
A lack of comparable evidence should not prevent a valuation from being undertaken
If there is a lack of comparable evidence:
Search further afield across wider range of indicators or indirect evidence e.g national economic data
Comment on any material uncertainty
What is a Discounted Cash Flow (DCF)?
Discounted Cash Flow -
A valuation model that seeks to determine the viability and investment value (or worth) of a real estate investment property by examining its future net income or projected cash flow from the investment and then discounting that cash flow to arrive at an estimated current value of the investment.
When would you use a DCF?
You would use a DCF to account for more complex assumptions accounting for a potential investors’ timings and cash flow requirements
What are the advantages of a DCF?
- Good for varying income flows like stepped rents, multi lets
- Useful when comparing investments
- Good for analysis - vary inputs, sensitive analysis
What are the disadvantages of a DCF?
- Requires more information than traditional method
- Potentially higher risk of error
- Time consuming
- Not always needed on straightforward project structures
What is present value?
the sum of the discounted values of a net cash flow, including all inflows and outflows excluding the initial outflow, where each receipt/payment is discounted to its present value at a specified discount rate
What is turnover?
Turnover - amount of money taken by a business in a particular period
What is a years purchased multiplier?
The multiplier of the net annual income to determine the capital value and it is useful to obtain the capital value of the property
What is intangible goodwill?
Intangible Goodwill - an asset (an asset that’s non-physical but offers long-term value) which arises when another company acquires a new business
e.g brand loyalty
How does market value differ to investment value/fair value?
Market Value is accounting for market forces
Investment and Fair Value not influenced by market forces
What is Fair Maintainable Turnover?
Fair Maintainable Turnover - the level of trade that a ‘reasonably efficient operator’ would expect to achieve on the assumption that the property is in good repair and suitably equipped
What is gross profit?
Gross Profit - the profit a business makes after subtracting all the costs that are related to manufacturing and selling its products or services
What is net profit?
Net Profit - actual profit after working expenses not included in the calculation of gross profit have been paid
What is a Reasonably Efficient Operator?
assumes that the market participants are competent operators, acting in an efficient manner, of a business conducted on the premises
What is residual land value?
Residual Land Value - the amount remaining once the gross. development cost of a project is deducted from its gross development value (GDV) and an appropriate return has been deducted
Explain what you understand by the term, margin of error.
Margin for error is a degree of deviation from a correct or exact value or target – accepted margin of error is between 10% either way
Name the basis of values?
- Market Value
- Market Rent
- Investment Value (or worth)
- Equitable value (fair value)
- Synergistic value
- Liquidation value
What is IFRS?
International Financial Reporting Standards
What is ‘marriage value’?
An additional element of value created by the combination of two or more interests or values.
Sometimes referred to as synergistic value.
What is a Red Book valuation
It is a valuation carried out in accordance with the guidance laid out in the RICS Valuation - Global Edition, and Global Standards UK Supplement.
RICS DCF definition
a valuation model that seeks to determine the value of real estate investment property by examining its future net income or projected cash flow from the investment then discounting that cash flow to arrive at an estimated current value of investment.
What is capitalisation?
When deciding on how much to bid in the open market for a right to recieve a flow of income, the investor will convert the flow of income into a capital sum.
What is decapitalisation?
Investment valuation of gaining the rental income from a capitalised sum.
Used in analysis of yields
What is one of the key objectives of an investment?
To provide an income.
What are yields used for?
To capitalise rents in valuation and decapitalise capital values in analysis.
