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