week 1 slides (2)
DESCRIPTION
TRANSCRIPT
Areas covered
• Role of valuations and valuer• Definitions of market value, price and worth• Five methods of commercial property
valuation– Applications– Methodology– Approach
Week 1
• Definitions, concepts and bases
Rationale
• What are valuations or appraisals?• Why is there a demand for valuations?• Why is there a (growing) demand for analysis
of worth or Investment Value?
Definitions
• Price - exchange value• Value – exchange or use value• Worth– Individual – Market
• Valuation - prediction of exchange price
“The estimated amount for which a property should exchange on the date of the valuation between a willing buyer and a willing seller in an arm’s-length transaction after property marketing wherein the parties has each
acted knowledgeably, prudently and without compulsion”
Market Value
Role of valuations
• Financial reporting and legal/statutory requirements
• Lending• Transaction related• Performance measurement• Insurance
Global definition of Investment Value
• The value of the property to a particular investor, or class of investors, for identified investment objectives.
Role of Investment Value calculations
• Buy/sell/hold decisions• Identifying over or underpricing• Choosing between competing assets• ‘Customising’ investment analysis to specific
circumstances of the investor
Key Points
• Distinction between price and worth• Valuers’ role has been concerned with price.• Increasing demand for analysis of prices and
calculations of worth• Market worth - based upon the assumption
that there is mis-pricing in the commercial property market
The Five Methods of Valuation
• Applications - when are they used?• Methodologies - how are they used?• Limitations - what are the problems with using
them?• NB - read recommended texts in conjunction
with the notes• Will be further developed in Year 2
The five methods
• The investment or income method• The residual method• The comparison method• The contractors or cost method• The profits or accounts method• NB - they are not mutually exclusive
Comparison Approach
• Used for the rental valuation of many types of commercial properties (in UK).
• Used for the valuation of residential property (in UK).
• Often used as a ‘check’ on other methods.• Globally - is most widely used for all types of
property.• Arguably most valuation methods have strong
elements of comparison.
Methodology
• Market transactions (deals) provide evidence of prevailing values.
• This evidence is then applied to the subject property.
• Appropriate adjustments are made where required.
• What does heterogeneity imply?
Limitations
• Data• Availability• Confidentiality• Quality• Timing• Retrospective• Overvaluation/
undervaluation
• Relevance• Heterogeneity• Adjustment• Subjective• Inconsistency• ‘Rules of thumb’
Residual approach
• Land - with development potential• Buildings with redevelopment potential• Incorporated into methods which require a
land valuation
Methodology
• Calculate value of development• Calculate cost of development - including
profit as a cost• Difference is the remainder that is available
for the purchase of land.
Limitations
• There is substantial uncertainty about the level of costs and revenues
• Techniques commonly used have some technical weaknesses
• However, these technical weaknesses may not matter. Why?
Investment method
• Derived from mainstream finance.• Focus on the income.• Value of an asset reflects the present value of
future income flows.• Used for commercial properties which
generate a rental income.• Most important method.
Methodology
• A number of variants.• Basic approach - apply a capitalisation rate to
income stream• Rents are set in the lease or obtained from
market evidence• Yields or capitalisation rates are obtained from
sales• We’ll see that the cap rate or yield is really a
multiplier.
Limitations
• Similar to comparison approach• Relies on market evidence• Retrospective• Uniqueness• Availability
Contractors method
• No market• Specialist purpose built• Operational purposes• Unusual - one off• Insurance• US - a mainstream
method
• Examples• Oil refinery• Church• Library• Sports Centre• Fire station• Hospital
Methodology
• Cost of rebuilding plus• Cost of land minus• Depreciation equals• Existing use value• See Red Book definition
Limitations
• Inputs are difficult to calculate• Apart from costs data• Land value?• Depreciation?
Profits Method
• Business and property are closely linked• Hotels/PFS/Restaurants/Cinemas/Pubs• Income payable is a function of the
profitability of the occupying business.• Income is capitalised to give a capital value.
Methodology
• Rent = Gross Profit - (Net Profit + Tenant Allowance)• Gross Profit = Gross earnings less purchases• Net profit = Gross profit less operating expenses• Tenant Allowance = Tenant’s salary, interest on
tenants investment and risk allowance• Capital value = Rent/ capitalisation rate
Limitations
• Retrospective - historic accounts.• May be misleading or inaccurate.• Trading performance issue.• Subjective.• Controversial.• Alternative approaches increasingly used
Key Points
• There is an important distinction between price and worth
• A valuation is an attempt to estimate market price
• A calculation of worth can be used to analyse this price
• There are five methods of estimating price or market value