RICS Valuation Level 2 Revision Notes PDF

VALUATION LEVEL 2 DEFINITIONS OF VALUER Commencing a Valuation Internal valuer 1) Compete...

VALUATION LEVEL 2 DEFINITIONS OF VALUER Commencing a Valuation Internal valuer 1) Competence employed by company to value assets of the company Do you have teh rleevant skills understandign and knoweldge For internal use only - no third party reliance (SUK)? If not, refer to RICS find a Surveyor External Valuer Has no material links with he asset to be valued, or the client 2) Independence Check for any conflicts or personal interests - Who and Why? 3) Terms of Engagement STAT DUE DILIGENCE Set out in writing full confirmation of instrucction to the client Required to check no material matters which could impact prior to starting work and receieve written confirmation back the valuation: of instruction 1) Asbestos register Confirm competence of valuer 2) Bsuienss rates/council tax Extent and limitations of valuers inpsections must be stated 3) Contamination 4) Equality Act 2010 compliance 5) Environmental matters - power lines, telecoms masts, flooding 6) EPC rating 7) Fire safety compliance 8) Highways (adpted or not) 9) Legal title and tenure - check boundaries, covenants, easements 10) Planning history and compliance (s.106 agreement) DEFINITIONS DEFINITIONS DEFINITIONS NET YIELD All RISKS YIELD The resulting All RISKS YIELD yield adjusted for purchasers costs The remunerative rate of interest used in the valuation of fully The remunerative rate of interest used in the valuation of fully let property let at market rent reflecting all the prospects and EQUIVALENT YIELD let property let at market rent reflecting all the prospects and risks attached to the particular investment Average weighted risks attached yield to the when a reversionary particular investment property is valued using an initial and reversionary yield TRUE YIELD TRUE YIELD Assumes rent is paid in advance not in arrears (traditional INITIAL YIELDrent is paid in advance not in arrears (traditional Assumes valuation practice assumes rent is paid in arrears) Simple income valuation yield practice for current assumes rentincome and is paid in current price arrears) NOMINAL YIELD REVERSIONARY NOMINAL YIELD YIELD Initial yield assuming rent paid in arrears Market rentassuming Initial yeild (MR) divided rentbypaid current price on an investment let in arrears at a rent below the MR GROSS YIELD GROSS YIELD The yield not adjusted for purchasers costs (such as an RUNNING YIELD The yield not adjusted for purchasers costs (such as an auction result) The yieldresult) auction at one moment in time VALUATION LEVEL 2 COMPARABLE METHOD RICS Professional Standard: Comparable Evidence in Real Estate Valuation 1st Ed. 2019 Principles in use of comparable evidence. Provides advice in dealing with situations where there is limited availability of evidence Sets out non-prescriptive hierarchy of evidence noting "valuer should use professional judgement to assess the relative importance of evidence on a case by case basis" 6 Steps: HOW TO FIND RELEVANT COMPARABLES 1) Search and select comparables inspection of an area to find recent market activity - seeking 2) Verify details, analyse headline rent, determine net effective agents boards rent Speak to local agents 3) Assemble comparables in schedule Auction Results (beware these are gross prices) 4) Adjust using hierarchy of evidence in-house records/ databases and webistes 5) Analyse comparables toform opinion of value Care needs to be taken when using auctions data as there may 6) Report and prepare file note be a special purchaser or insolvency sale Market sentiment can be importance where there is a lack of transactional evidence The date of evidence is crucial, hence the focus on "contemporary" in the hierarchy above HIERARCHY OF EVIDENCE Category A - direct comparables Category B - general market data that Category C - other sources completed transactions of near can provide guidance transactional evidence from other real identical properties - full and accurate info from published sources or estate types and locations info available commercial databases - importance other background data - interest rates; completed transactions of other depends on relevance, authority and stock market movement & returns similar assets - full and accurate info verifiability which can give an indication for real available other indirect evidence (eg. indices) estate yields completed transactions of other historic evidence similar assets - full data may not be demand/supply data for rent, owner available but enough reliable data is occupation, or investment available similar real estate being marketed - offers maybe made but no binding contract completed askign prices (only with careful analysis) VALUATION LEVEL 2 INVESTMENT METHOD Used when there is an income stream to value Rental income is capitalised to produce capital value Conventional method assumes growth implicit valuation approach Implied growth rate is derived from the market capitalisation rate (yield) Conventional Investment Method Rent received, or market rent, multiplied by the years purchase (YP) to calculate Market Value Importance of comparables to rents and yeild YIELD (%) = (Annual Income / Property Value) * 100 ↘ = Return on investment per annum YEARS PURCHASE (YP) =1 / Yield ↘ = The Capitalisation rate ↘ The number of years worth of income that would amount to Asset Value ↘ YP IS THE INVERSE OF YIELD ↘ eg/ 5% Yield = 1 / 0.05 = 20YP, or ↘ 20YP = 1 / 20 = 0.05 (* 100) = 5% Yield Term & Reversion Layer/Hardcore Method Used for reversionary investments (ie. when under rented - Used for over rented investments Market Rent is more than passing rent) income flow divided horizontally Term - the value of the property during teh current lease Bottom slice = Market Rent period. Capitalised until next review or lease expiry, at an Top slice = Rent passing less Market Rent until next lease event initial yield Higher yeild applied to top slice to reflect additioanl risk Reversion - the value of teh property after the current lease Different yields used depending on comparable investment period. Market Rent valued in perpetuity at a reversionary yield evidence and relative risk (Market rent / Current Price) DISCOUNTED CASH FLOW Growth explicit investment method of valuation - It is a form of income approach valuation A DCF seeks to dertermine value by examining its future net income or projected cash flow from the property and then dicounting cash flow to arrive at an estimntaed current value of the property Used where projected cash flows are explicitly estimated over a finite period short leasehold interest with income voids or compelx tenures phased development projects non-standard investments (say with 21 year rent review) Over rented properties or social housing The approach seperates out and explicitly identifes growth assumptions rather than incorporating them within an All Risks Yield RICS Practice Information: Dicounted Cash Flow valuations, Novemeber 2023 Explicit DCF valuation versus the implicit method of valuation The context for applying explicit DCF methods Differences between inputs for market value and investment method Simple Methodoligy to find Net Present Value (NPV) Internal Rate of Return (IRR) market Value The sume of the The rate of return at which all future cash flows must be 1) Estimate Cash flow discounted cash flows of discounted to producea NPV of zero (income less expenditure) the project The IRR is used to asses the total return from an investment for an agreed holding A NPV can be used to opportunity making some assumptions regarding rental period determine if an investment growth, re-letting and exit assumptions 2) Estimate exit value at the gives a postive return Use linear interpolaton to estimate IRR end of the holding period against a target rate of To calculate IRR: 3) Select the discount rate return 1) Input current market value as a negative cash flow 4) Discount the cash flow at When the NPV is positive, 2) Input projected rents over holding period as a positive value the discount rate the investment has 3) Input projected exit value at the end of the term assumes as 5) Value is the sum of the exceeded the target rate of a positive value completed discounted return 4) Discount rate (IRR) is the rate chosen which provides a NPV cash flow to provide the When the NPV is negative, of zero NPV it has not achieved the 5) If the NPV is more than zero, the target rate of return has target rate been met VALUATION LEVEL 2 PROFITS METHOD OF VALUATION Purpose: Used for valuations of trade related property, where tehre is a 'monopoly' position Used where the value of the property depends upon the profitability of its business and its trading potential Used for pubs, petrol stations, hotels, childresn nurseries, leisure and health care properties etc Basic principle is that the value of the property depends on the profit generated from the business, not the physcial building or location Must have accruate and audited 3 yrs accounts Use estimates/business plan for a new busienss, if needed Adjust for maturity of business and any unaccpetable or exceptional items of expenditure Simple methodology Annual turnover (income) less costs/purchases = GROSS PROFIT Less reasonable workign expenses = UADJUSTED NET PROFIT Less operators remuneration = Adjusted net profit, known as, FAIR MAINTAINABLE OPERATING PROFIT (FMOP) This can be expressed as EBITDA (earnings before interest, tax, depreciation and amortisation) Capitalised at an appropriate yield (YP multiplier) to achieve market value Cross check with comparable sales evidence if possible VALUATION LEVEL 2 RESIDUAL METHOD (& DEVELOPMENT APPRAISAL) Purpose: Tool to financially assess viability of a development scheme Can be used to establish a residual site value Can also be used to assess profitability of a proposed scheme and its sensitivity to changing inputs, or assessing the viability of different uses, rents yields or financial contributions, such as S.106 or CIL payment Development Appraisal Residual Site Valuation Calc or series of calcs to establish Most common purpose is for a specific valuation of a property value/viability/profitability/suitability of a proposed holding to find the market value of teh site based on inputs developement based on the clients inputs (at one monet in time, at the val. date, for a particular purpose) Can assume a site value or calculate a site value Form of development appraisal Provides guidance as to the viability of the proposed Based upon simple residual val or DCF method development All inputs taken at date of Val. Residual Site Valuation Methodology Gross Development Value (GDV) = capital val. of completed scheme Use plans if needed and measure on CAD Valued at current date assuming present values and market conditions Comparable method used to establish rents and yield All risks yield used Allowance for rent free period or tenants incentives and mareketing void is assumed Purchasers costs usually deducted for commercial property vals. 1) Estimate the GDV Calculate expected market value of the finished developement. Research comparables in the area considering specifcations of the proposed development 2) Deduct Development Costs Construction costs Professional fees (architects, engineers etc) Finance costs (interest on development loans) Marketing and sales costs Contingency allowance (typically percentage of constructions costs) 3) Subtract Profit Margin Determine reasonable profit margin - usually expressed as percentage of the GDV or as a fixed return on investment 4) Calculate Residual Land Value Residual Land Value = GDV - (Development Costs + Profit Margin) 5) Evaluate Results Compare residual land value to asking price of the land. If land value is higher than asking price, the project may be profitable. Otherwise, adjustments to costs, price expectations or purchase negotiations may be necessary CONSIDERATIONS Market Conditions - Always consider current and forecasted market conditions as they can impact the GDV and development costs Regulatory Environment - Be aware of local planning regs and restrictions that could impact feasibility and costs Sensitivity analysis - Conduct sensitivity anlaysis to undersatnd how chnages in key assumptions (such as costs or sales proces) impact the residual land value VALUATION LEVEL 2 CONTRACTORS METHOD (DEPRECIATED REPLACMENT COST (DRC)) Purpose: Used for owner occupied property For accounts purposes for specialised properties Also used for rating valuations of specialist properties Should only be used wjere direct market evidence is limited or unavailble for specialised properties Specialised properties could include: sewage works, lighthouses, oil refineries docks, schools etc Simple methodology 1) Value of land in its existing use (assume planning permission exists) 2) Add current cost of repalcing the building, plus fees, less a discount for depreciation and obsolescence/deterioration (Use BCIS and then judge level of obsolescence) Have to estimate amount of depreciation appropriate for physical functional and economic obsolescence Physical is the result of deteroration/wear and tear over the years Functional is where the design or spec no longer fulfills the function for what it was originally designed Economic is due to changing market conditions for the use of the asset RICS GUIDANCE NOTE: DEPRECIATED REPLACEMENT COST METHOD OF VALUATION FOR FINANCIAL REPORTING, 2018 VALUATION LEVEL 2 RICS VALUATION - GLOBAL STANDARDS 2021 ("RED BOOK GLOBAL") Effective 31st Jan 2022 Provides internationally recognized guidance for valuers. Ensures valuations are performed consistently and ethically. Part 1 - Introduction Part 2 - Glossary Part 3 - Professional Standards (PS) Part 4 - Valuation technique and performance standards (VPS) Part 5 - Valuation Applications (VPGA) Part 6 - The International Valuation Standards (IVS) Changes from previous version: Need for compliance with the RBG and adequate terms of reference to reflect this (PS1 and VPS1) Terms of reference must be clear in that valuations are either RBG compliant or not Sustainability and ESG factors Mandatory use for all vals except for the following FIVE exceptions to VPS 1-5 (YOU MUST KNOW THESE): 1) Advice is expressly provided in preperation for, or during course of negotiations or litigation 2) The valuer is performing a stautory function except for the provision of a valuation for inclusion in a statutory return to a tax authority 3) Valuation is provided for a client purely for internal purposes, without liability, and not communicated to any third party 4) The valuation is provided as part of agency and brokerage work in anticipation of receiving instructions to dispose of, or acquire, an asset, except when a purchase report is required which includes a valuation 5) The valuation advice is provided in anticipation of giving evidence as an expert witness Terms of Engagement (IVS 101) VPS 3 Valuation Reports (IVS 103 Reporting) 1) ID and status of valuer 1) ID and status of valuer 2) ID of client 2) ID of client / ID of any other intended user 3) ID of any other intended user 3) Purpose of valuation 4) Asset to be valued (or portfolio) 4) Asset to be valued (or portfolio) 5) Currency 5) Basis of Value 6) Purpose of Valuation 6) Valuation date 7) Basis of Value 7) Extent of Investigation 8) Valuation date 8) Nature and source of info relied upon 9) Extent of Investigation 9) Assumptions and special asssumptions to be made 10) Nature and source of info relied upon 10) Format of the report 11) Assumptions and special asssumptions to be made 11) Restrictions on use, distribution and publication 12) Format of the report 12) Confirmation of Red Book compliance / undertaken in 13) Restrictions for use, distribution and publication accordance with IVS standards 14) Confirmation of Red Book compliance 13) Valuation approach and reasoning 15) Fee basis 14) Valuation figure(s) 16) Complaints handing procedure 15) Comment on market uncertainty 17) Statement that valuation may be subject to compliance by 16) Limitiation on liability agreed (PII) the RICS 18) Limitiation on liability agreed (PII) Bases of Value (Defintions) (There are 6 in total - focus on below 4) 1) Market Value - Estimated amount for which an asset or liability should be exchanged On the valuation date / between willing buyer and willing seller / in arm lengths transaction / after proper marketing / parties acting knowledgeably, prudently, without compulsion 2) Market Rent - Estimated amount which an interest in real property should be leased including all of above plus / on apprpriate lease terms 3) Fair Value (IFRS13) - Price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants Required if IFRS have been adopted by the client RICS view is that this is generally consistent with the definition of market rent 4) Investment Value - Value of an asset to a particular owner or prosepctive owner for individual investment or operational objectives May differ from Market Value Sometimes used as a measure of worth to reflect value against clients investment criteria VALUATION LEVEL 2 MATERIAL UNCERTAINTY Refers to situations where the reliability of a valuation is affected by uncertain market conditions or external factors, making it challenging to establish an accurate property value. This concept acknowledges that certain unpredictable conditions can impact a valuer’s confidence in their valuation, suggesting that the results should be treated with additional caution. For instance, when significant, unprecedented, or rapid changes in the market occur, the availability of comparable transaction data may decrease, making it harder to benchmark a property’s value accurately. This was notably observed during events like the COVID-19 pandemic or periods of financial market volatility, where traditional indicators became less reliable. Prevelant in Residential currently owing to building safety matters Application of Material Uncertainty in Valuations In practice, a valuer will declare material uncertainty to inform stakeholders (clients, investors, lenders, etc.) of the limitations associated with the valuation report under certain conditions. This transparency allows users to interpret the valuation in light of the prevailing uncertainties, which may influence their decision-making. For example, if a valuer is asked to appraise a commercial office building during an economic downturn, the lack of recent comparable transactions in the sector may necessitate declaring material uncertainty. This indicates that the valuation should be considered with caution, potentially impacting lending or investment decisions. Relevant Sections in the RICS Red Book Red Book outlines material uncertainty in several areas, particularly under: VPGA 10 (Valuation Practice Guidance – Special Considerations) Provides specific guidance on how to approach material uncertainty and when it should be applied, especially for valuations affected by exceptional market conditions. PS 2 (Professional Standards, Section 2): Addresses the communication of uncertainty within valuation reports, emphasising transparency and explaining the basis for such uncertainties to clients. VPS 3 (Valuation Practice Statements, Section 3): Details the need to communicate and explain uncertainty, including the types of valuation methods that may be impacted under uncertain conditions and the necessary disclosures. The emphasis across these sections is on the ethical responsibility of valuers to disclose material uncertainty where appropriate, safeguarding the interests of clients and promoting trust in the valuation profession.