R.E. Appraisal & Valuations (Peter Wyatt)
R.E. Appraisal & Valuations (Peter Wyatt)
The relationship between the price paid (capital value) and the rent paid (rental value) - the
all risks yield or cap rate
Valuing Rack Rented Freeholds
2 pieces of info: 1. the contractually agreed rent and 2. ARY, which is an estimate obtained from analysing transactions involving comparable properties
is used to compare investments
is derived from comparable properties that have already sold and let
describes ratio of income to capital value
is often similar for comparable properties in a locality
The ARY is a generic term for different types of yield, but all are ratios between rent and capital value, and all encapsulate the 'risks' associated with the investment...
The nature of the different risks are: Risk to the income, risks to the physical asset, legal and/or legislative threats, future trends
Present (capital) Value = MR/ARY
Purchase Costs and Net Initial Yields
NIY is the amount invested, as opposed to the price paid and the rental income
the total amount invested is price paid plus purchase costs such as stamp duty land tax etc.
Valuing Freehold Rack-rented Property Investments
NIY = MR / (price x 1.065)
When analysing comparable evidence to obtain yields, add transaction costs to the price paid. When valuing, deduct transaction costs from the capital value
Valuing Reversionary Freehold Property Investments
Not all investment properties for sale are let at MR at the time of sale. Two tranches of income must be valued: the current rent until it can change and the new (rack) rent in the future.
Core and Top Slice
Core = 1/r + Top Slice = 1/r x (1+r)^-n
Adjustments to Yields: 1.
the core is over-valued because it does not grow yet it is capitalised at a
the top-slice is under valued because the MR is current rather than projected
the top-slice is highly sensitive to MR estimate and it contains all growth, so what yield to use?
can't deduce splits from deals: is technique losing relevance in a world with shorter leases, more break clauses and potentially more voids?
Term and Reversion
Term = 1-(1+r)^-n/r + Reversion = 1/r x (1+r)^-n
Adjustment to Yields:
term yield implies growth where there is none, so over-values the term.
Reversion MR is at today's rent rather than in 3 years time, so the reversion is under-valued.
Both errors roughly cancel each other out, but sometimes valuers reduce the term yield slighly.
YP 'x' years @ 'x'%
Value of Term
Reversion to MR
YP in perp @ 'x'%
PV 'x' years @ 'x'%
Value of Reversion
4 pieces of info. are needed: 1. MR 2. Rent passing 3. Period of time to reversion 4. Yield
risk, rental growth, etc. in yield choice
for security, liquidity, management, etc. are also implied in the ARY
not permit comparison with non real estate investments
The ARY tech. is a simplified DCF. Where the cash does not vary the YP (PV £1 pa) can be used. But many property investments have net cash flows that vary so ARY approach is unsuitable for many investment problems e.g. - reversionary freehold investments. - leasehold investments with complex profit rents.
Less rent paid
YP x years @ 8%
Valuation (gross of costs)
Less rent paid
YP x years @ x%
Valuation (gross of costs)
Used when your comparable is let at less than MR
Equivalent yield is the rate that makes the PV of the rental cash flows = sale price, i.e. it is a growth-implicit IRR
Determine both the term NIY and the reversion NIY
At 'x'% trial EY:
YP 'x' yrs @ 'x'
YP perp @ 'x'%
PV £1 'x' yrs @ 'x'
Less acquisition price
Net Present Value
X = (EY2 – EY1) x NPV1 / (NPV1 + NPV2)
ignore the minus value of NPV2 if necessary
EY1 = lower trial rate. EY2 = higher trial rate. NPV1 = NPV at lower EY. NPV2 = NPV at higher trial rate.
Add lower trial rate to x for final answer.
- rental growth is applied explicitly to the rental cash flow
g = ((r-y)(1+r)^p + y / r)^1/p -1
income at the investor’s target rate (and therefore requires an assumption for target rate of return)
explicit about growth by applying a ‘growth rate’ to the income flow
recommended for multi-let investments
DCF and ARY techniques will diverge more as 'g' increases
Valuers collect evidence to estimate value of comparable properties, recently transacted in the market (excluding those not conducted at arms length). Evidence can be ranked in terms of its reliability:
verifiable information from public sources and media
incomplete, unverifiable but agreed transactions of similar properties
completed transaction, similar property, most data available and reasonably reliable
asking prices and rents
completed transaction, same property, full and accurate verifiable information
indices and other information, from a mass valuation data set for example
Similarity between properties is considered by various comparison metrics:
type of tenure rights: degree of similarity in terms of the nature and extent of rights held
date of transaction, including market conditions at the time of the sale or letting
location :proximity to the property being valued
physical attributes, including current and potential land uses
Leases are interests
law provides backdrop to negotiations and resultant structures
wherever hallmarks of a lease are present (i.e. exclusive possession for a fixed or ascertainable period) the arrangement is a lease
is the cost of occupation
usually estimated by analyzing
of recent transactions in similar properties and applying that evidence to the subject property/interest being using
units of comparison
physical characteristics of the property, location and environment
terms of the lease (length, frequency of rent reviews, burden of restrictions that have an effect on rental value)
DATES of any future rent reviews and the basis on which the rent is to be assessed at rent review are vital
Adjustment of Comparables
Type of transaction
(perceived as true rental value as tested in market but terms aren't renegotiated in light of changes to the lease in the drafting stages - also leasing incentives can distort rent)
Units of Comparison
Industrial - GIA, Offices - NIA, Retails -
Area in Terms of Zone A
, Farms - Gross Area in hectares
Hierarchy of Evidence
Market Letting in similar building
Rent Review/Lease renewal in same building
Market Letting in same building
Rent Review/Lease Renewal in similar building
Best Comparable evidence:
recent, nearby, similar use, similar size, same type of tenure, similar covenant, similar condition, open market transaction
Adjustment of Rent
e.g. repairs and insurance: the more the tenant has to pay for repairs the less they can afford to pay in rent
Also: security of tenure provisions, improvements, additional benefits e.g. parking and lease length
, the longer the period between rent reviews the more the tenant will offer
, in general the greater the restriction on user the lower the rental value
EITHER OWNER OCCUPIED OR LEASED COMMERCIAL PROPERTY
Zoning Retail Space
greater ability to display goods, greater potential for sales
this 'display' potential must be reflected in value
significant trade can be created by spontaneous 'window shopping'
trading area nearest the front is most valuable
value of a 'standard' shop is driven by trade potential
3 GF zones plus a remainder
remainder valued at 10-12.5% of Zone A
upper floors not zoned and valued at a % of zone A, depending on use
Market Value =
Rental Value =
Investment Value =
Capital Value =
All Risks Yield = MR/P. The unit of comparison used to value property investments.
Initial Yield = Is a particular type of income yield. The net income received in the first year divided by purchase price.
The NIY is a ratio between the amount invested (as opposed to the price paid) and the rental income. E.g. NIY = MR/(Price x 1.065).
Reversionary Yield = the ratio between the reversionary market rent and the capital value.
Equivalent Yield = an overall yield that can be used to capitalise both the current and reversionary incomes. It will be very close to the ARY.
Exit Yield =
Hurdle Rate =
Discount Rate = The rate of return that is expected from a property investment.
Target rate = The rate of return that is expected from a property investment.
Reversionary = Properties for sale that are not rented at the MR at the time of sale.
Rack Rented = market rent
YP = Years Purchase
YP in perpetuity = 1/ARY
YP is a multiplier and is the inverse of the yield, it is the PRESENT VALUE OF £1 per annum.
YP 'x' years = 1-(1+r)^-n/r
Why are Vals needed?
They support lending decisions, insurance risk assessment and the reporting of fair value of land and property assets in financial statements.
Government has specific requirements for valuations:
• In relation to taxation, it may be necessary to value very large numbers of land and property holdings on a regular basis
• Regarding expropriation of tenure rights, assessments of market and non-market value will be required on an individual basis.
They are key in decisions about whether to invest or develop land
Support trading of tenure rights.
• They provide liquidity to sales and lettings markets by supplementing price information with valuations
• This is particularly important when transactions are infrequent or when market information is inaccessible, unreliable or unverifiable
Accounting for land and property assets
Real estate investment
Privatization of state-owed assets
Planning and development policies
Land and property taxation