Valuation Methods
Direct Comparable
-
-
-
Based on comparing the Properties to be valued directly with other comparable
properties (same property type/same market segment) which recently changed
hands or leased – recent transactions (generally located in the surrounding areas or
in another market which is comparable to the Properties)
Appropriate adjustments: weight against respective advantages – heterogeneous
nature of real estate properties (eg. Date of transaction, location ,size, building
design & layout, building age, size (quantum reduction? Allowance/adjustment)
luxury residential? Whole floor office?), floor level, view & orientation) allow for any
qualitative and quantitative difference that may affect the price/rental likely to be
achieved by the Properties under consideration
Factors (eg. Tenants covenants, trade mix) are difficult to be quantified in the overall
unit value of the comparables
Zoning method (UK)
Income Approach (Investment approach): for rental received property
-
Traditional:
o Based on the capitalisation of the current passing rental income and
potential reversionary income of the property from the date of valuation at
appropriate investment yields to arrive at the capital value
o Determine rental values from recent lettings and to derive information on
yield ranges from analysis of recent sales, the summation of all future rental
income. The process of summation is called capitalisation which takes the
present value of these future income into consideration
o Derive the capital value (CV) from the rental income (ie. Capitalisation of
rental incomes
o Present value technique (PVT): measure the value of an asset by the present
value of its future economic cash flow, which is cash that is generated over a
period of time by an asset, group of assets, or business enterprise
o Appropriate adjustments/deductions for rent-free period, ongoing vacant
voids/marketing periods and non-recoverable expenses for the vacant space
have been allowed
o More accurately reflect the property specific factors by utilising various
specific assumptions which have been derived via analysis of market
evidence
o All-risks yield: = Overall Capitalization Rate = Net rental income/sales price;
yield having considered on all risks involved in the market incorporating risks
like expected rate of return (growth), opportunity cost (time) and risk
premium
o Initial yield (passing yield) – Net Current Income/Current Market Value
o Reversionary yield – Estimated Rental Value (ERV or Rack Rent)/Current
Market Value; Rent reviewed to market level in near future
o Traditional valuations do not quantify the growth
o
-
Ranges of capitalisation rate adopted in the Linkreit valuations: Retail (34.2%)
Discounted Cash Flow:
o Require periodic net cash flows to be forecasted over the life of the
investment (Incorporates an assumed 10-year holding period and the
reversionary value in year eleven) and discounted at a risk-adjusted
opportunity cost of capital to arrive at a new present value
o Consider the yearly net cash flows after deductions for expenditure and the
assumptions made relating to rental growth projections, vacancies, rent
frees, replacement reserve, non-recoverable outgoings and leasing costs
o Discounts the future cash flow back to the present to find the current value
of an investment property (discounted the projected future income by an
expected internal rate of return)
o Forecasting of future rental trends with the presumption of a sale at the end
of a specified holding period (forecast the income and expenditure over the
life of the investment)
o Allow for void periods where there is no rental income from the property
o Cash flows: are forecasted forward for a certain period of time which include
 The net of receipts and expenses during the period
 The terminal value for sale at the end of the period (resale value)
 Then the cash flow will be discounted by a discount rate which
reflects the risks associated with the asset and the anticipated
return required by the investors
o All-risks yield = equated yield + rental growth
o If the project is being evaluated to reflect estimate returns from alternative
investment opportunities, then a rate would be selected that would reflect
the opportunity cost of the investment project. Eg, Treasury bond rates if a
secure and relatively risk-free investment is required as a comparator
o After discount rate selected, input in decimal form into the present value
(PV) formula and the PV multiplier is then calculated for the desire time
period over which the cash flow would be received. The PV multiplier is then
applied to the cash flow to adjust the future cash flow into present day
terms
o Reflect a period of income which corresponds to the time elapsed between
rent reviews, the estimate and attribution of growth to the initial rent is
achieved by the application of the compounding (or amount of $1) formula.
Inflated income stream is capitalised by the application of the years’
purchase, for a short finite term (or the present value of $1 per annum)
formula and then discounted back using the present value of $1 formula to
reflect the time elapsed before the rental uplift of the period in question.
Once all these operations have been applied to the rental income, the result
is the DCF for one period between rent review will result in a series of DCFs
being produced. Sum together will give the new present value (NPV) of the
investment. Effectively the NPV represents the investment value, or value of
worth for an investor at a given rate of return
o NPV assess an investment relative to a selected yield, Internal rate of return
(IRR) determines the return produced by a particular income profit, reported
o
o
o
as a yield, not an amount. IRR is useful in non-market appraisals making use
of the investor’s required target rate or opportunity cost, as well as enabling
an investor to compare 2 prospective investments.
IRR (the rate at which an investment breaks even): the discount rate; all NPV
of the cash flow from a project equal zero, equated yield means IRR.
Measures the true and exact return given the estimated future rental
incomes. Different from ARY because equated yield reflects fully the exact
time preference of future money. It is the target rate that required in DCF
model. The higher a project’s IRR, the more desirable it is to undertake the
project
DCF technique enables all the cash flows (incoming and outgoing) to be
discounted at a selected rate of interest, which represents the investor’s
target rate of return (or an approximation thereof). When all the cash flows
are summed (having regard to their signs) the result will be the new present
value (NPV). If the target rate of return has been achieved, the NPV will be
zero; if it has been exceeded, the NPV will give a positive balance; and if the
NPV is negative, then the target rate of return has not been achieved.
DCF enable 2 projects to be compared based on their NPV and IRR
Residual Method:
-
-
-
-
Assessing the highest and best use of the site within the economic, legal and
planning framework
For undeveloped or value land with obsolescent buildings (redevelopment)/used
where there is potential for development, redevelopment or refurbishment
Calculate the difference between the final value of the redeveloped site and the cost
of carrying out the development work, sufficient to give the developer a satisfactory
return that takes account of the risks inherent in such an undertaking
Estimate the gross development value (GDV), which is the capital value of the
completed development at the date of valuation. Floor area of the proposed
building is calculated and multiplied by the rent per square metre to find the total
rental value. Multiplied by the years’ purchase in perpetuity at an all-risks yield that
has been identified through the analysis of the market. Market rent (or rack rent)
capitalised in perpetuity for a freehold valuation or, if leasehold, for the length of
the ground lease available.
GDV is calculated using a combination of the investment method and the
comparative methods outlined above
Residual Value (RV) = GDV – Cost of development (Construction costs, Cos of finance
& professional fee, Taxation & Marketing cost)- Return to cover risk & profit (=
allowance for developer’s risk and profit) (say 20% of capital value)
Convert RV to PV (eg. PV 2 yrs @15% p.a. : 1/[(1+0.15)^2])
Subject to a number of hypothetical assumptions
Profit (receipts and Expenditure Approach):
-
Assuming rent/value is related to profit
-
-
-
-
-
-
Applicable properties: public utilities, hotels, petrol filing station, cinema, etc; for
monopoly, unique business like theme park (when enough comparable information
is not available to determine the value of the property)
Judge the performance of a business by reviewing several sets of accounts (trading
account) to establish the most recent financial trends in the business history
because reference to only the most recent accounts may not be sufficiently
representative of the general trading situation (Profit & Loss Account, Balance
Sheet, Cash Flow Statement), Analyse the accounts by different ratios (profitability
ratios, liquidity ratios, solvency ratios, efficiency rations)
In the absence of rental evidence, recourse may be had to trading receipts and
expenditure as an indication of the rent which the occupier might reasonably be
expected to pay if he were to rent the property [from PR]
Care must be taken to ensure that it is the property (the tenement) which is valued,
and note the business itself
“From the gross receipts of the undertakers for the preceding year they deducted
working expenses, an allowance for tenant’s profit and the cost of repairs and other
statutory deductions and treated the balance remaining (which should presumably
represent the rent which a tenant would eb willing to pay for the undertaking) as
the rateable value of the entire concern.”
Share between Landlord and Tenant (estimating the tenant’s share: (a) a percentage
return on tenant’s capital; (b) a percentage on gross receipts; (c) a proportion of the
divisible balance; or (d) a spot figure)
The return to tenant in running the business (tenant’s share)
The return to landlord
Major value component is driven by the profitability of the business that occupy the
buildings and not simply the land/buildings themselves
Gross profit: gross earnings-purchases
Net profit: gross profit – working expenses
Less
Less
Less
Receipts
Operating Costs
Divisible Balance
Tenant’s Share
Rent and Rates
Rates
Rent (ie. Rateable Value)
$
A
(B)
C
(D)
E
(F)
G
Cost-based Approach (Contractor’s Method):
-
Assuming rent/value is related to cost (construction cost less depreciation & value of
land)
Applicable properties: school, hospital, recreation club, plant and machinery, etc.)
For no market information, specialised building which are seldom bough or sold.
Investment approach cant be adopted, such as school, hospitals, airport, power
stations
-
-
-
Link the value of building to the value of the site and cost of construction (Value of
the Building = Value of the Site + Cost of Construction); Land price + construction
cost – depreciation
o Stage 1: Estimate cost of the site work, buildings, rateable structures, and
rateable plant and machinery
o Stage 2: Adjust the replacement cost to reflect any deficiencies in the
buildings etc. Determination of the effective capital value is made reference
to the estimated cost, inclusive of fees, or reconstructing the existing
building, known as the replacement cost approach. For the new building, the
effective capital value might be the actual cost of construction.
o Stage 3: Value the land
o Stage 4: Decapitalize the sum of Stage 2 and 3 by the appropriate interest
rate
o Stage 5: Stand back and look at the result of stage 4 and make any further
adjustments considered appropriate
This method of valuation can be adopted for tenements which are rarely let, hence
rental evidence is normally not available, and in respect of which the receipts and
expenditure method is considered inappropriate. It can also be used for the
valuation of apart of a tenement for which other parts are valued on a comparison
basis, such as a certain recreational facility or for rateable plant and machinery
[from PR]
In Hong Kong, the practice in the application of the Contractor’s Basis is to use the
financial market rate or the property market yield to decapitalize the effective
capital value to arrive at the annual value as defined in section 7(2) of the Rating
Ordinance
Add
Add
Add
-
Estimated adjusted cost of buildings and
rateable improvements as at the valuation
date, including fee
Finance charges
Land value
Carrying costs for land
Total adjusted costs
X Decapitalisation rate (%)
$
A
B
C
D
E
Rateable Value
Recommends the price a buyer should pay for a piece of property should equal the
cost to build an equivalent structure
Market price of the property = cost of land +cost of construction – depreciation
Less reliable than other methods