ERES 2012
Reversionary Freeholds:
Valuation Methods Revisited
Nick French
Professor in Real Estate
& DTZ Fellow in Commercial Property
Department of Real Estate & Construction
Oxford Brookes University
Email: nick.french@brookes.ac.uk
Agenda
 Valuation Methods – UK (Investment Approach)
 Term and Reversion Method – differential yields
 Term and Reversion Method – equivalent yields
 Hardcore/Layer Method – differential yields
 Hardcore/Layer Method – equivalent yields
 DCF Method – Target Rate and ARY in perp
 Valuation Methods in Practice




Pilot Study - Survey
Initial Results
RICS Guidance
DCF - guidance from the RICS and IVSC
Market Uncertainty
2012 Property Forecasts
“In this world nothing can be said to be certain, except
death and taxes” Benjamin Franklin (1789)
Comment: Advice on Valuation Uncertainty is now a prerequisite
“It will be about the Euro in 2012. As long as it
continues as it is, banks won’t lend and occupiers
won’t make decisions” Anthony Leonard, Hines (2012)
Comment: There is a stagnation in the market due to uncertainty
The fortunes of secondary/tertiary assets will depend
on who owns it. If owned by good asset managers then
they will continue to perform. If not, they will continue
to fall in value” James Scott, Commercial Estates (2012)
Comment: Value will be determined by cash flows - DCF
Market Uncertainty
2012 Property Forecasts
“On a micro-level, a lot of tertiary and secondary stock
(in the M4 corridor) will become worthless”
Miff Chichester, St Congar Properties (2012)
Comment: Reversionary value will be critical NOT YP perp
“The pressure on the banks in terms of capital
requirements and liquidity is going to become very
intensive. They will have to make more sales”
Ian Marcus, Credit Suisse (2012)
“We may have reached the limits of trying to adapt
traditional (valuation) methods”
Tim Havard, Oakbrook Consultancy (2012)
Comment: Valuers will need to be able to assess value from first
principles and NOT by comparison
The Red Book
Valuation Approaches
There are now THREE approaches to valuation:

MARKET APPROACH
 COMPARABLE METHOD

COST APPROACH
 CONTRACTORS METHOD
 This incorporates Depreciated Replacement Cost

INCOME APPROACH
 INVESTMENT METHOD (implicit and explicit)
 RESIDUAL METHOD
 PROFITS or ACCOUNTS METHOD
Valuation and Worth
 VALUATION - the process of determining market
value. An estimation of the price of exchange in the
market place using market information and
expectations
 CALCULATION OF WORTH – The process of
determining the worth of a property asset or business
based on specified forecasts of the future that may
differ from market expectations
 MAREKT VALUE and INVESTEMNT VALUE (WORTH)
TERM AND REVERSION
CASH FLOW
REVERSION
MR
Rent
Passing
TERM
1st
review
perp
LAYER CASH FLOW
RERVERSION
MR
Rent
Passing
TERM
1st review
perp
VALUATION EXAMPLE
Rent Passing £750,000, MR £1m, ARY 8%, TR
10.75%
 Term and Reversion
 Layer
 Short – cut DCF
 Full DCF (not illustrated)
£ 11,855,726
£ 11,855,726
£ 11,953,848
£ 11,953,848
Each of the methods produce similar answers (DCF 0.83%
higher) and the choice of method in “normal” circumstances will
not mis-price the asset. However in certain situations (e.g. Overrenting and recessionary markets) traditional methods, poorly
adapted, could produce erroneous answers.
IMPLICIT VALUATION
Term and Reversion Method
Rent Passing
£ 750,000
YP 3 years @ 8.00% 2.58
MR
YP perp @ 8.00%
£1,932,823
£ 1,000,000
12.50
PV 3 years @ 8.00% 0.79
£9,922,903
£11,855,726
IMPLICIT VALUATION
Layer Method
Rent Passing (layer) £ 750,000
YP perp @ 8.00% 12.50
£9,375,000
Top Slice
£ 250,000
YP perp @ 8.00%
12.50
PV 3 years @ 8.00% 0.79
£2,480,726
£ 11,855,726
EXPLICIT VALUATION
Short Cut DCF Method
Rent Passing
£750,000
YP 3 years @ 10.75% 2.45
£1,840,785
MR (grown 3 yrs at 3.2%) £1,099,016
YP perp @ 8.00%
12.50
PV 3 years @ 10.75% 0.74

11,953,848
£10,113,063
£
Survey Results
All valuations were Layer with adjustment to yields on BOTH layer & top slice
Total number of
respondents
Number involved in
Valuation only
Number involved in
other tasks
Number not doing
valuations
12/25
7
4
1
Do you feel that
you have sufficient
evidence of ARYs?
Do you feel that
you have sufficient
evidence to adjust
yields?
If you undertake
valuations, do you
feel that you have
sufficient guidance
from the RICS?
Yes
No
1
n/a
Yes
No
6
0
0
7
1
6
n/a
Yes
No
4
0
1
0
4
0
1
0
4
0
1
n/a
Survey Results
 The majority of all respondents felt there was





insufficient guidance from the RICS on method
All respondents felt there was adjustments to ARY
were made arbitrarily
69% of all responding valuers felt there was sufficient
guidance on valuations from the RICS
Comment - “Often valuations are undertaken in
isolation of any evidence”
Comment - “Valuations are presented as just numbers
on spreadsheet/software without any explanation”
Comment - “Valuation methods (by generic software)
are being often made by individuals who are not
trained and who do not understand value”