Check lecture for assessment tips Assessment 1 explanations (check module outlines and learning resources)

Assessment 2: in-class test (check module outlines and learning resources)

 

2 Classifications of Estates

  • Based on rights
    • Estate in possession
    • Estate not in possession
  • Based on Possession
    • Freehold – indefinite period of time
    • Leasehold – expires on a definite date

 

Lecture 2: The Regulation

 

Learning Objectives

  • The Red Book – RICS Valuation Global Standard
  • Why is regulation necessary?
  • RICS Global Professional and Ethical Standard
  • The Bases of Value
  • RICS Code for Leasing Business Premises
  • Discount Cashflow (DCF), Net Present Value (NPV) and Internal Rate of Return (IRR)

 

The Red Book

  • Professional Standards (PS) 1&2
  • Valuation Practice Standards (VPS) 1-5
  • International Valuation Standards (IVS)
    • Standards in undertaking valuation assignments which promote transparency and consistency in valuation practice
  • Aims to motivate confidence in, and provide assurance to clients and recognised users that a valuation provided by an RICS-qualified professional anywhere in the world will be undertaken to the highest standard

When does the red book apply?

  • Exemptions
    • Advice during the course of litigation
    • Statutory function
    • During negotiations
    • Internal valuations
    • Certain agency or brokerage work
    • Expert witness reports

RICS Global Professional and Ethical Standards

  • PS1: Compliance with standards where a written valuation is provided
  • PS2: Ethics, competency, Objectivity and disclosures
  1. Professional and ethical standards
  2. Member qualification
  3. Independence, objectivity, confidentiality and the identification and management of conflicts of interest
  4. Maintaining strict separation between advisers
  5. Disclosures where the public has an interest / upon which third parties may rely
  6. Reviewing another valuer’s valuation
  7. Terms of engagement (scope of work) 8. Responsibility for the valuation

RICS Five Professional and Ethical Standards

  1. Act with Integrity
  2. Provide high standard of service
  3. Act to promote trust in the profession
  4. Treat others with respect
  5. Take responsibility

Valuation Technical and Performance Standards (VPS)

  • VPS 1 – Terms of engagement (scope of work)
  • VPS 2 – Inspections, Investigations and Records
  • VPS 3 – Valuation Reports
  • VPS 4 – Bases of value
    • A statement of fundamental measurement assumptions of a valuation
  • VPS 5 – Valuation Approaches and Methods

Market Value

  • Estimated amount for which an asset or liability should exchange on the valuation date, between a willing buyer and a willing seller after proper marketing

Market Rent

  • Estimated amount for which an interest in real property would lease on the valuation date between a willing lessor and a willing lessee on appropriate lease terms

The Baes of 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
      • Or
    • The estimated price for the transfer of an asset or liability between identified knowledgeable and willing parties that reflects the respective interests of those parties
  • Existing Use Value
    • Estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller assuming that the buyer is granted vacant possession of all parts of the asset required by the business and disregarding potential alternative uses of the asset that would cause it Market Value to differ from that needed to replace the remaining service potential at least cost
  • VGPA 10 – Matters that may give rise to material valuation uncertainty
    • Identify Uncertainty
    • Nature or location
    • Restriction of information
    • Method of valuation
    • Hope
    • Legal changes
    • Market Instability

Investment Valuation

  • Future Value/Compound Interest
    • (1+𝑖)ⁿ
    • I = interest rate, n = time periods
  • Present Value (PV)
    • (1+𝑖)‾ⁿ or 1/(1+𝑖)ⁿ
  • Net Present Value (NPV)
    • Takes into account initial cost of investment (present value doesn’t)
    • NPV = V – X
    • Present value of expected cash flows are calculated by discounting them at the required rate of return
    • If V > X, NPV > 0, the project has a positive NPV and should be invested in. The rate of return yielded by the investment is greater than the target rate.
    • If V < X, NPV < 0, the project has a negative NPV and should not be invested in. The rate of return yielded by the investment is less than the target rate.
  • Internal Rate of Return (IRR)
    • IRR = 𝑖 + [ (r – 𝑖) x NPV 𝑖____ ] NPVr + NPV𝑖
    • I = interest rate with +ve NPV
    • R = interest rate with -ve NPV
  • Discount Cash Flow (DCF)

 

Lecture 3: Valuation Practice

 

Learning Objectives

  • RICS Code of Measuring Practice 2015
  • The Valuation Approaches and Methods
  • The Comparison Methods
  • The UK Traditional Methods
  • The Critics of the UK Traditional Methods

 

RICS Code of Measuring Practice 2015

  • Aims to improve the quality and fairness of negotiations on lease terms and promote efficiency
  • Enables negotiations to proceed so that each party can make an informed decision

Negotiations and heads of terms

  • The agreement as to the terms of the lease on a vacant possession letting must be recorded in written heads of terms
  • Aims to produce letting terms that achieve a fair balance between parties having regard to their respective commercial interests
  • The landlord/letting agent will be responsible for ensuring that heads of terms completing with those provisions are in place before the initial draft lease is circulated

Purpose of the Code

  • To provide succinct, precise definitions to permit the accurate measurement of buildings and land, the calculation of areas and volumes, and description or specification of land and buildings on a common and consistent basis
  • Gross External Area (GEA)
    • Area of building measured externally at each floor level
  • Gross Internal Area (GIA)
    • Area of building measured to the internal face of the perimeter walls at each floor level
    • Building costs estimation/estate agency and valuation/new homes valuation
  • Net Internal Area (NIA)
    • The usable area within a building measured to the internal face of the perimeter walls at each floor level
    • Estate agency and valuation/property management/rating
  • Residential Valuations (RV)
    • Net Sales Area (NSA)
      • The GIA of a new or existing residential dwelling
      • Valuation and marketing of residential dwellings, particularly in new developments
    • Effective Floor Area
      • Useable area of the rooms within a building measured to the internal face of the walls of those rooms
      • Used for council tax banding of flats and maisonettes

The Valuation Approaches and Methods

  • 3 principal valuation approaches
    • Marketing Approach (Comparative)
    • Income Approach (Investment and Profit)
    • Cost Approach (Residual and Depreciated Replacement Cost DRC)
  • 5 methods of valuation
    • Comparative
    • Investment
    • Profits
    • Residual
    • Cost
  • Use of valuation approaches
    • Aims to find the most appropriate method in each circumstance:
      • The appropriate basis of value and premise of value determined by the terms and purpose of the valuation assignment
      • The respective strengths and weaknesses of the possible valuation approaches and methods
      • The appropriateness of each method in the nature of the asset, and the approaches or methods used by participants in the relevant market
      • The availability of reliable information needed to apply the method
    • All approaches based on economic principles of price equilibrium, application of benefits/substitution
    • Valuer’s responsibility to choose the appropriate method for each valuation engagement
    • Compliance with IVS requires the valuer to use a method not defined or mentioned in the IVS
    • Price information from an active market is considered to be strongest evidence of value

The Market Approach (Comparative)

  • Provides an indication of value by comparing the asset with identical or comparable assets for which price information is available:
    • The subject asset has recently been sold
    • The subject asset or similar assets are actively publicly traded
    • There are frequent and/or recent observable transactions in similar assets
  • When comparable market information does not relate:
    • Valuer must perform a comparative analysis of qualitative and quantitative similarities and differences between the comparable assets and subject asset and adjust on this comparative analysis

Income Approach (investment and Profit)

  • Provides an indication of value by converting future cash flow to a single current value
  • The value of an asset is determined by reference to the value of income, cash flow or cost savings generated by the asset
    • Income-producing ability of the asset is the critical element affecting value from a participant perspective
    • Reasonable projections of amount and timing of future income are available for the subject asset

Cost Approach (Residual and Depreciated Replacement Cost DRC)

  • Provides an indication of value using the economic principle that a buyer will pay not more for an asset than the cost to obtain an asset of equal utility, whether by purchase or by construction, unless undue time, inconvenience, risk or other factors are involved
  • Provides an indication of value by calculating the current replacement or reproduction cost of an asset and making deductions for physical deterioration and all other relevant forms of obsolescence
  • Should be applied when:
    • Participants are able to recreate an asset with substantially the same utility as the subject asset
    • Asset is not directly income-generating
    • The basis of value being used is fundamentally based on replacement cost such as replacement value

Market Approach: Comparative Valuation

  • Comparable evidence is at the heart of virtually all real estate valuations
  • Must be:
    • Comprehensive – Number of comparables rather than just 1
    • Similarity
    • Recent
    • Verifiable
    • Consistent with local market price
  • Comparable evidence in Real Estate
    • Key principles:
      • Building age and condition (cost and time)
      • Building specification and layout
      • Efficiency and adaptability
      • Legal terms (freehold/leasehold, tenure/term of lease)
      • Limitations of use
      • Location
      • Size
      • Transaction Date
    • 2 stages of analysis
      • Establishing a common measurement or other comparison standard
      • Adjusting comparable evidence
        • Location, building specification, alteration, condition, legal situation, timing of transaction
      • Residential Valuation
        • Market Evidence:
          • Direct Transactional Evidence
          • Published Databases
          • Indices
          • Automated valuation models
        • 2 stages of analysis
          • Establish common measurement or other comparison standard
          • RICS Code of Measuring Practice (2007) Residential Valuations (RV)

Income Approach: Traditional Valuation

  • Future Value (FV)/ Compound Interest
    • (1+𝑖)ⁿ
    • i = interest rate, n = time periods;
  • Present Value (PV)
    • (1+𝑖)‾ⁿ or 1 / (1+𝑖)ⁿ
  • Years’ Purchase (YP) in Perpetuity
    • 1/i
  • PV of £1 p.a./Years’ Purchase (YP
    • YP = (1-PV)/i

Types of Yield

  • Initial yield
    • Relationship between passing rent and price
  • Net initial yield
    • Relationship between passing rent and price considering purchaser costs
  • Equivalent Yield
    • Time weighted average between term yield and reversionary yield
  • Equated Yield
    • Internal rate of return where net present value = 0
  • Exit Yield
    • Used in Discount CF to calculate exit value
  • Running Yield
    • Annual income of investment divided by current market value
  • All Risk Yield
    • Relationship between passing rent and price where property has recently been let at the market rent and recently sold

Value = product of rental income x yield

  • Will be adjusted due to circumstances
    • Length of lease
    • Current strengths
    • Redevelopment opportunities
    • Location
    • Amenities
    • Age of property

 

Lecture 4: Traditional and Contemporary Valuation

 

Learning Objectives

  • The Criticisms of the UK Traditional Methods
  • The Responses to the Criticisms of the Traditional Methods – Equivalent Yield and Short-cut DCF
  • The Contemporary Methods – DCF
  • The Parry’s Valuation Tables
  • The use of Excel/spreadsheet

 

Mathematical examples

 

The traditional Valuation Criticisms

  • Growth implicit valuations based on concept of the all-risks-yield containing all the qualities of the investment cashflow – growth potential + risk – capitalisation
  • ARY wraps up all investor expectations about rental growth and property risks which causes problems in valuation where there is imperfect comparable evidence
  • Term income is fixed but reversionary income has growth potential. Valuer applies Growth Implicit ARY to both
  • Valuer is over-valuing the term and under-valuing the reversion
  • Income approach for freehold interest is the capitalisation of a property’s actual or potential rental income by using income multipliers/years’ purchase

Equivalent-yield method (responds to criticisms)

  • Criticisms on previous 2 models based upon mathematical problems and adjustments are eliminated via this method
  • Equivalent yield is the only yield one can derive by analysis
  • Indicates the true all-risk yield of the investment
  • Model only as good as comparables on which it is based

Short cut DCF (responds to criticisms)

  • Valuers looking for alternative valuation approach during periods of high inflation

Leasehold Interest

  • Finite duration
  • Lease can only have a market value if it produces an income and if lease is assignable

Contemporary Valuation

  • Discount Cash Flow (DCF)
    • Discounts all future costs and receipts from an investment to produce a NPV
      • NPV = sum of future cash flows receivable discounted at given target rate of return – initial cost of investment
      • NPV is the present value of all the income and expenditure of the investment, if positive, the investment meets investor’s target return
    • Shows income stream and inflation
    • Versatile as it can accommodate varying costs and revenues over different time periods
    • Recognises time value of money by adopting a discount rate that enables investors to assess its overall profitability
    • Used to derive values of:
      • Rent
      • Yield
      • Growth rate
      • Discount rate
      • Costs
      • Disposal price
    • Investment appraisal
      • Can be used to compare different investments by showing the NPV using a target rate of return – the return that the investor requires for the investment
    • Valuation (Market Value)
      • Internal Rate of Return Approach (IRR)
        • Rate of return where NPV = 0 when present value of income = present value of costs of and expenditure
      • Growth Explicit Technique
        • Target rate of return R = RFr + RP + I
          • R = target rate of return
          • RF = Risk-Free rate (Gilt rate)
          • RP = Risk Premium
          • I = inflation
        • Growth rate ARY = R – g (growth rate)
        • The equated yield is defined as the discount rate which needs to be applied to the projected income so that the summation of all the income flows discounted at this rate, equals the capital outlay

 

Coursework Information

 

Lecture 5: Commercial Property Valuation

 

Learning Objectives

  • Types of commercial properties
  • Valuation of warehouse and industrial properties
  • Valuation of offices
  • Valuation of Retail Property
  • Zoning ITZA and Half-back method

 

IVS Valuation Approach and Methods

  • 3 principal valuation approaches
    • Market approach (Comparative)
    • Income approach (Investment and profit)
    • Cost approach (Residual and Depreciated Replacement Cost DRC)
  • 5 methods of valuation
    • Comparative
    • Investment
    • Profits
    • Residual
    • Cost

Types of commercial properties

  • Retail
    • Single shops/stalls/kiosks
    • Shopping centres
    • Department stores
    • Retail outlets
  • Office
    • Shop style units
    • Floor above shop style units
    • Office buildings
    • Carparks
  • Industrial
    • Heavy industrial plants
    • Factories
    • High-tech office
  • Warehouse
    • Storage

Commercial Property: Comparative method of Valuation

  • Warehouse
    • GIA or cubic capacity
    • Adaptability – cash and carry
    • Yield
  • Industrial
    • Location
    • Access to transport/proximity to the supply of suitable labour
    • Construction/natural lighting/working heights/floor strength/parking/loading facilities
    • Valuation
      • GIA – Market Value not a function of size
      • Yield – 6-10%
      • Owner occupied
      • Multi-storey let
    • Office
      • Location: CBD/suburbs, access to transport, potential size, access to labour
      • Number and type of tenants, terms of tenancy
      • Potential repair/insurance costs
      • Services: lifts/receptions/security/WIFI
      • Facilities/amenities
      • Valuation
        • NIA
        • Comparative and capitalisation
        • Owner occupied
        • Multi-storey let
      • Retail
        • Location
        • Number and type of tenants
        • Type of premise: single shop/department store/retail warehouse
        • Terms of lease
        • Valuation
          • NIA
          • Comparative and capitalisation
          • Zoning and Halving back method
            • Zone A, B, C
            • Zone A = 1
            • Zone B = ½
            • Zone C = ¼
            • Remainder = 1/8
            • 1st Floor/LG sale area = 1-%
          • Retail – Prime High Street
            • Net Internal Area (NIA) and in terms of Zone A (ITZA)

 

Lecture 8:

 

Discount cash flow