Valuation principles

Question 1

Briefly describe the residual method of valuation

Answer 1

1. Determine the highest value use
2. Calculate the GDV (using the comparables method)
3. Deduct costs
   a) Building costs
   b) Demolition costs
   c) Site prep
   d) Fees (surveyors, professional fees etc)
   e) Marketing
   f ) CIL
   g) Contingencies
   h) Finance

Question 2

In what scenario would you use the residual method?

Answer 2

The residual method is typically used for property or land with development potential. The output is market value of the land.

Question 3

What is the difference between a residual valuation and a development appraisal?

Answer 3

1. Residual land valuation - output is the market value of the land
2. Development appraisal - output is the profitability or viability of the development

Question 4

What is the investment method used for?

Answer 4

The investment method is used where there is an income stream to value, i.e. the property is tenanted. This can include commercial, residential, retail, industrial and agricultural properties.

Question 5

How do you carry out a valuation using the investment method?

Answer 5

The investment method is used to determine the market value of a freehold/leasehold property from its potential to generate future income.

Where the tenant is providing the landlord with a return on their investment on the capital lost (purchasing the building).

1. Assess rental values (market rent) and a market-based yield. A yield can be simply defined as the annual return on investment expressed as a percentage of capital value
2. The profit is calculated based on the assessment of the future rental income, which is then discounted back to the present day giving the net present value (NPV)
3. This is finally used as an indicator of how much the building is presently worth.

Question 6

When is the profits method used?

Answer 6

The profits method is used for specialist income-producing properties. E.g.

• hotels
• golf courses
• petrol stations
• care homes

These types of properties are only usually sold as part of a business and are designed specifically for the intended use. Their value will depend on business profitability and trading potential, also known as intangible goodwill.

Question 7

Briefly describe the principles of the profit method.

Answer 7

Introduces the concept of market value vs. investment value; the latter relating to the ‘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’.

1. Involves establishing fair maintainable operating profit (FMOP) capable of being generated by a reasonably efficient operator (REO).
2. This is based upon assessment and analysis of fair maintainable turnover (FMT)
3. A market-based profit multiplier is then used to convert FMT into a capital value

Question 8

Describe the concept and usage of the contractor method

Answer 8

The contractor method is used for owner-occupied or specialised property that is rarely sold on the open market.

It is also known as the method of last resort and should not be used where there are market sales of comparable properties.

Is based upon the assumption that the market will pay no more for the existing property than the amount it would cost to buy an equivalent site, plus the cost of constructing an equivalent building.

Question 9

Provide a brief overview of the principles of the contractor method is practice

Answer 9

The basic steps involved include assessing the cost to replace the land and the building – with a modern equivalent, including all associated costs – before making appropriate deductions for depreciation and obsolescence.

Question 10

What published resource would you use to inform the correct way to use the comparable method?

Answer 10

RICS Guidance Note:
Comparable evidence in real estate valuation 1st edition, October 2019

Question 11

Name 7 characteristics of a good schedule of comparables, according to RICS: Comparable Evidence in Real Estate 2019

Answer 11

1. Comprehensive – there should be several comparables rather than a single transaction or event
2. Very similar or, if possible, identical to the item being valued
3. Recent, i.e. representative of the market on the date of valuation
4. The result of an arm’s-length transaction in the market
5. Verifiable
6. Consistent with local market practice and
7. The result of underlying demand, i.e. comparable transactions have taken place with enough potential bidders to create an active market

Question 12

What are the two primary standards set-out within the Red Book?

Answer 12

1. PS 1 - Compliance with standards where a written valuation is provided
   
   1. Looks at application - when a valuation needs to be Red Book Global compliant & the exemptions
2. PS 2 - Ethics, competency, objectivity and disclosures
   
   1. Compliance with the Rules of Conduct

Question 13

How does the UK National Supplement to the Red Book differ from the Global standards?

Answer 13

The UK national supplement sets out specific requirements, together with supporting guidance for members on the application of the Global Standards in the UK. Effectively, this includes other authoritative requirements specific to UK jurisdiction and subject to UK laws. This includes valuations for things like CGT (Capital Gains Tax) or ATED (Annual Tax on Enveloped Dwellings).

Question 14

Which sections of the Red Book are of mandatory or advisory application?

Answer 14

Professional Statements - PS 1-2 - these are mandatory for all members providing written valuations

Valuation Technical and Performance Standards - VPS 1-5 - these are mandatory unless otherwise stated. VPS 1, 4 and 5 focus on technical standards, whilst VPS 2-3 focus on performance and delivery

Valuation Practice Guidance Applications - VPGA 1-10 - these are advisory and provide guidance on best practice. They typically relate to valuations for specific purposes or of specific asset types, e.g. financial statements, secured lending, trade related property and portfolios

Question 15

What are the 5 exemptions from the Red Book?

Answer 15

1. Providing agency or brokerage advice for an acquisition or disposal
2. Acting as an expert witness
3. Performing statutory functions
4. Providing a valuation purely for internal purposes, without liability and without communication to a third party
5. Providing valuation advice in the course of negotiations or litigation where the valuer is acting as an advocate

Question 16

What checks should you carry out prior to accepting a valuation instruction according to the Red Book?

Answer 16

Before accepting an instruction, you need to ensure you comply with PS 2 - Ethics, competency, objectivity and disclosures.

E.g. conflict of interest money laundering etc.

Question 17

What does the Red Book state must be included within terms of engagement?

Answer 17

Identification and status of the valuer
Identification of the client(s)
Identification of other intended users
Identification of the asset(s)/liability(ies) being valued
Currency
Purpose
Basis of value (see VPS 4)
Valuation date
Nature and extent of investigations and limitations
Nature and source of information relied upon
Assumptions and special assumptions
Format of the report
Restrictions on use, distribution and publication
Confirmation of compliance with IVS
Fee basis
Reference to Complaints Handling Procedure
Statement relating to monitoring by RICS
Any limitations on liability agreed

Question 18

What are the Red Book bases of Value?

Answer 18

1. Market Value
2. Market Rent
3. Investment Value
4. Fair Value
5. Assumptions

Question 19

What does rack rented mean?

Answer 19

A rack rent is usually a rent that represents the full open market annual value of a holding, often simply called the market rent

Question 20

Name the four key sections / standards set out within the Red Book.

Answer 20

1. Professional Standards (mandatory)
2. Valuation technical and performance standards (mandatory)
3. RICS global valuation practice guidance – applications (VPGAs) (advisory)
4. National or jurisdictional standards

Question 21

Which document should be referenced in relation to the valuation elements of your BtR work?

Answer 21

Valuing residential property purpose built for renting 1st edition, 2018

Question 22

Name the key difference between the valuation of residential property purpose built for renting, and the valuation of commercial property purpose built for renting.

Answer 22

In residential rented property - the responsibility for maintenance of the tenanted demise sits with the landlord.

Question 23

What are the key steps involved in valuing a BtR asset?

(Valuing Residential Property Purpose Built for Renting, 2018)

Answer 23

1. Assessment of Gross Income
2. Assessment of Operating Expenditure
3. Net Operating Income
4. Net Income Capitalisation
5. Allowance for Capex or Lease up
6. Checks / benchmarking (e.g. Discounted cash flow / break up potential)

Question 24

Based on the RICS Guidance Note Valuing Residential Property Purpose Built for Renting (2018), what steps of the valuation process for BtR assets do you assist with?

Answer 24

1. Assessment of Gross Income
2. Assessment of Operating Expenditure
3. Net Operating Income

Question 25

What steps would be taken by a BtR valuer, following the provision of a G2N model from SAY?

(Valuing Residential Property Purpose Built for Renting (2018)

Answer 25

Capitalise the Net Income

• Make allowance for purchasers costs (e.g. SDLT, agent fees etc)
• Where the ‘stabilised’ (steady state) income is being capitalised, an allowance should be made for lease-up
• Adjustments to the yield should be made to reflect comparable transactions (location, security of tenure etc)

Question 26

What are the Red Book Valuation Technical & Performance Standards?

Answer 26

VPS 1 - Terms of Engagement (scope of work)
VPS 2 - Inspections, investigations and records
VPS 3 - Valuation reports
VPS 4 - Bases of value, assumptions and special assumptions
VPS 5 - Valuation approaches and methods