Comparison
method
1
Comparison Method
INTRODUCTION
2
Introduction
• Valuation is the prediction of human behaviour in the market place
• Prediction of human behaviour is commonly done by looking at recent
behaviour in similar situations and assuming this will be repeated
• In a market place it is assumed that humans adopt a rational economic
approach
• So we analyse prices/rents that buyers/tenants have paid recently and
assume that they would do the same in the future
• Valuation paradox:
– The built environment is not a laboratory and valuations will vary but the
calculations performed in valuations assume ceteris paribus.
– No two properties are the same (heterogeneous) yet valuation relies on the
comparison of properties to give an indication of value
– Solution: the valuer must identify and quantify differences in type,
location, legal interest, quality and the state of the market
Comparison method
• US refers to sales comparison
• UK refers to comparison in more general sense as it covers lease
pricing as well as capital asset pricing
• Comparison is both a method and a principle
• Comparison method:
– Collect and check evidence
– Select and adjust value factors
– Reconcile comparables and value subject property
4
Information needed for a comparable
• In the light of the above, the valuer needs to know for each
comparable.
• Locational characteristics
• Physical Characteristics
• Lease terms (confirmation of terms form…)

Type of transaction (new letting, rent review, lease renewal)

Rent and any lease incentives (e.g. premiums, rent-free periods)

User clauses

Tenant fit-outs

Service charges

Security of tenure

Repair obligations

Insurance responsibility
Example Question
• Value an industrial property, S, with a GIA of 325 m2
• A comparable property, C (arm’s length transaction, similar age,
condition, location, lease structure and design), has a GIA of 350 m2
– Purchased by an investor for £135,000
– New 15 year lease with 5 year rent reviews at a rent of £12,200
Answer
• Devaluation (analysis of a comparable to extract unit of comparison)
– Rental Value / m2 = rent / GIA = 12,200 / 350 = £34.85 per m2
– Yield = rental value / capital value = 12,200 / 135,000 = 9%
• Valuation
– Estimated Rental Value (ERV) of S = area x rental value / m2 = 325 m2 x
£34.85 per m2 = £11,325
– Capital Value (CV) of S = ERV / yield = 11,325 / 0.09 = £126,000
Comparison metrics:
yields and rents
Attributes that might make one property different from another and
explain differences in value could be put into three main groups (other
groupings are possible)
1.
2.
3.
Physical Structure, construction, size condition etc
Locational factors, amenities, accessibility, transport
Legal constraints, lease terms, planning
The two key metrics for commercial real estate are rents and yields:
• Rents – data more readily available. Analysis and adjustment is a key
skill
• Yields - sales are limited and often difficult to analyse especially if let
at less then market rent
Comparison Method
RENTAL ANALYSIS
9
Rental Analysis
Units of Comparison
• To compare two or more properties we need a common unit of
comparison
• For rental values use floor area e.g.
– Industrial -> Gross Internal Area (GIA)
– Offices -> Net Internal Area (NIA)
– Retails -> Area in Terms of Zone A (ITZA)
– Farms -> Gross Area in hectares
• Refer RICS Code of Measuring Practice
• The rent for each comparable must be converted to a rent/m2. This can
be done before or after adjustment for differences
Adjustment of rent comparables
• The comparable will need to be adjusted to allow for differences in
location, physical factors and lease terms
• Procedure is to adjust the rent actually agreed to a rent that might
have been agreed if the comparable was in same location, was
similar physically and had been let on the same terms as those that
are to be assumed for the property to be valued
• Must also consider type of transaction
•
•
•
new letting
rent review
lease renewal
Adjustment of rent comparables:
lease terms
The lease terms that are likely to impact on the rent a tenant would offer
include:
•
•
•
•
•
•
•
Lease length: may not have an enormous effect unless very different e.g. 1
year v 25 years
Repair obligations and insurance responsibility: the more a tenant has to pay
for repairs the less they can afford to pay in rent
User clause/restrictions: in general, the greater the restriction on user the
lower the rental value
Review pattern/frequency/basis: in general, the longer the period between
rent reviews, the more the tenant will offer
Rent free periods, premiums and other lease incentives: trying to estimate
effective rent from headline rents of comparables
Security of tenure provisions
Additional Benefits e.g. parking
Different Review Patterns
• The presumption is that a tenant will offer a different amount
depending on the frequency of the rent reviews.
• In general, the longer the period between rent reviews, the more the
tenant will offer.
• So if my comparable has 5 year rent reviews but the property I am
valuing has 3 year rent reviews I will need to adjust the comparable
rent - how do I do this? See handout and spreadsheet on FBEWeb
• See Baum, Mackmin and Nunnington pp106-107
Rent Free Periods
• A difficult area - various approaches
• See Bond and Brown and compare with
• www.voa.gov.uk/instructions/chapters/rating_manual/vol4/sect5/fra
me.htm
• See link from FBEWeb under comparables analysis
• Remember we are trying to find the rent that the tenant would have
paid if they had not agreed a rent free period
Adjustment of rent comparables:
comparables matrix
Comp
Adjustments
Agreed
Rent
Adjusted
Rent
Rent per
Sq.m.
A
Rent agreed one
year ago, increase
by 10%
20,000
22,000
120
B
One year rent free
period
30,000
27,000
100
C
No adjustment
25,000
25,000
115
D
3 year review
pattern
37,000
38,000
130
E
No adjustment
45,000
45,000
112
Adjustment of rent comparables:
the valuation
• We now need a technique that enables us to take the information
from the comparables and form an opinion of value.
• Most valuers will go through a subjective thought process
• ‘I think the property I am valuing (A) is better than comparable B
because it (A) is newer than B’
• ‘A is not as good as C because C has Air Con and A does not’
• To help with this a comparable grid or matrix might be used which
might involve ranking
Adjustment of rent comparables:
comparables matrix (ranked)
Comp
Attributes
Rent per
Sq.m.
B
You could have several columns
one for each of the main
attributes
100
E
that you consider are significant
determinants of value
112
C
115
A
120
D
130
Comparison Method:
Rental Analysis
A first floor office suite of 1,000 m2 has just been let at £15,000 per
annum. The landlord is liable for maintaining the structure and the
common parts and the insurance of the building. A service charge covers
the cost of heating and lighting. The landlord’s liability amounts to £3 /
m2. What is the net rent?
Admissibility v. Weight of Evidence








Recent
Nearby
Similar use
Similar size
Same type of tenure
Similar covenant
Similar condition
Open market transaction
importance
• Some evidence may not be admissible e.g. ‘hearsay’
• Evidence which is closest to the subject property in terms of
comparability will carry the greatest weight
• Best comparable evidence is:
Adjustment of rent comparables:
summary
•
•
•
•
•
•
Gather as much comparable data as possible
Reject any inadmissible comparables
Adjust remaining comparables to bring in line with subject property
Convert to an appropriate unit of comparison
E.g Office Rent Comparable = adjusted rent/NIA
You will now have a list of comparables, their attributes and the
rents/sq.m.
Comparison Method
YIELD ANALYSIS
21
Relationship between income
and capital value: yield analysis
• If investment property is sold and is let at market rent (MR) then
(initial) yield = rent/price
• If let at less than MR then
– Initial yield = rent passing / price
– Reversionary yield = MR/price
– Can also calculate equivalent yield. See later…
•
Another way of writing that equation is
Valuation
–
–
=
50,000 x 1/0.07
=
50,000 x 14.2857
=
714,286
1/YIELD in the formula is known as the YEAR’S PURCHASE (YP)
YP is a multiplier and is the inverse of the yield, it is the present value of
£1 per annum
22
Yields:
before the 1960s…
MR
10,000
YP perpetuity @ 10%*
Valuation
10
£100,000
*investor’s target return & therefore comparable with other investments
•
•
•
•
Negligible growth, no rent reviews, no reversions
Freehold valued at growth explicit yield at gilts + risk premium
Valuation was a growth explicit (no growth) DCF assuming constant
cash flow
LH valued assuming static rent - dual rate allowed comparison with FH
Yields:
after the 1960s
FRV
10,000
YP perpetuity @ 8%*
12.5
Valuation
£125,000
*growth implicit ARY, not the target rate & not comparable with other investments
•
Capital & income growth, rent reviews, reversions
•
Target rate now depended on growth potential as well as opportunity
cost and risk
•
Investors were prepared to accept lower returns today in expectation of
higher returns in the future
•
FH valued at growth implicit ARY at gilts + risk premium - growth
•
LH can now have varying & geared profit rents
Comparison Method:
Rent and yield analysis
• Value an industrial property
with a GIA of 325 m2
• A comparable property, C
(arm’s length transaction,
similar age, condition, location,
lease structure and design), has
a GIA of 350 m2
– Purchased by an investor for
£135,000
– New 15 year lease with 5 year
rent reviews at a rent of
£12,200
Comparison Method:
Rent and yield analysis
• Devaluation (analysis of a comparable to extract unit of comparison)
– Rental Value/m2 = rent/GIA = 12,200/350 = £34.85/m2
– Yield = rental value/capital value = 12,200/135,000 = 9%
• Valuation
– Estimated Rental Value (ERV) of S = area x rental value/m2 = 325m2 x
£34.85/m2 = £11,325
– Capital Value (CV) of S = ERV / yield = 11,325 / 0.09 = £126,000
ZONING
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Comparison Method
Zoning
• Trading area nearest front of shop is
most valuable
• Areas are ‘zoned’ on the ground floor,
and the value attributed to each zone is
‘halved back’ from front to rear
• Area behind Zone C (the ‘remainder’)
may be valued at a flat rate or £x/8psm
• Return or rear frontage may affect value
• Also, overall method and quantum
allowance
7 m frontage
Zone A
6m
Zone B
(valued at half
Zone A)
6m
Zone C
(valued at quarter
Zone A)
4m
The Principle of ZONING
• rental/capital value of shop is dictated by potential level of
trade
• significant trade is created by spontaneous “window
shopping”
• thus, the greater the ability to display goods the greater the
potential for sales
• this “display” potential must be reflected in value
• look at these two shops:-
Zoning
• Used to measure
standard retail
properties
• Reflects fact that
trading area nearest
the front is the most
valuable
7 m frontage
Zone A
(£x / m2)
Zone B
(£x/2 / m2)
Zone C
(£x/4 / m2)
6.1m
6.1 m
4m
The Principle of ZONING
Both shops have identical floor area
10
m
Which is most valuable?
Shop 2 because
it has a greater
display potential
18 m
18 m
1
2
High Street
10
m
The Principle of ZONING
• So, how do we build in that difference in value?
• Answer: we divide the shop into different “zones” of value:
• In pre-metric days, these zones were 20’ deep. These days,
valuers often use the nearest metric equivalent (6.1m), but
different
• The most valuable is the one next to the frontage, each
subsequent zone is worth 50% of the previous one
The Principle of ZONING
Using 5m deep zones
remainder
C
B
18m
1
2
10m
A
High Street
The Principle of ZONING
Shop 1
Shop 2
Zone A = 5 x 10 = 50 sq.m
Zone A = 5 x 18 = 90 sq.m
Zone B = 5 x 10 = 50 sq.m
Zone B = 5 x 18 = 90 sq.m
Zone C = 5 x 10 = 50 sq.m
rem
= 3 x 10 = 30 sq.m
10 m
Let zone A =
£1800/sq.m
R
C
18 m
B
18 m
1
2
A
High Street
10 m
(approx £180/sq.ft)
The Principle of ZONING
Shop 1
The Valuation
Zone A = 5 x 10 = 50 sq.m @ £1,800
=
£ 90,000 pa
Zone B = 5 x 10 = 50 sq.m @ £900
=
£ 45,000 pa
Zone C = 5 x 10 = 50 sq.m @ £450
=
£ 22,500 pa
rem
=
£
Shop 2
= 3 x 10 = 30 sq.m @ £225
Total rental value
Zone A = 5 x 18 = 90 sq.m @ £1,800
6,750 pa
£164,250 pa
=
£162,000 pa
Zone B = 5 x 18 = 90 sq.m @ £ 900
=
Total rental value
£ 81,000 pa
£243,000 pa
The Principle of ZONING
Rental value =
£164,250 pa
18
m
1
2
Rental value = £243,000
pa
High Street
10
m
Zone A rents in West Region
LOCATION
Prime
£/m2/ ann
ZP 1
Secondary
£/m2/ ann
ZP 1
Bournemouth
2,000
1,600
Weymouth
1,200
700
Exeter
2,400
950
950
475
Plymouth
1,950
1,000
Truro
1,750
925
Taunton
1,600
700
Bath
2,650
1,300
Bristol
2,200
1,250
Gloucester
1,600
900
Swindon
2,100
1,000
Barnstaple
Source VOA report – Jan 2008
Question
• Using the zoning principle, calculate
the rental value of the retail
property shown. You should use a
zone A rate of £1,400/sq.m and 6m
deep zones.
• Hint: Include all space in the
“remainder” at the same rate/sq.m
• Have a go!
26m
3m
frontage
Answer
•
•
•
•
Zone A = 3m x
Zone B = 3m x
Zone C = 3m x
Rem = 3m x
6m = 18sq.m @ £1,400/sq.m = £25,200
6m = 18sq.m @ £700/sq.m = £12,600
6m = 18sq.m @ £350/sq.m = £ 6,300
8m = 24sq.m @ £175/sq.m = £ 4,200
26m
Rem
C
B
•
TOTAL RENTAL VALUE = £48,300pa
A
3m
frontage
Question
• Shop 2 has just been let for
£63,000 pa. Analyse this
transaction to find the value
of Zone A.
• Use this zone A rate to value
shop 1
• Use 6m deep zones
Try it….
18m
18m
11
9m
22
4m
4m
12m
12m
Answer
18
m
• Analyse Shop 2
• Zone A = 4 x 6 = 24 sq.m @ £x/sq.m
= 24 X
• Zone B = 4 x 6 = 24 sq.m @ £0.5x sq.m
= 12 X
•
•
1
9
m
TOTAL area in terms of zone A(ITZA) = 36X let at £63,000
Therefore X (zone A rate)
= £1750/sq.m/pa
• Apply results to Shop 1
• Zone A = 9 x 6 = 54 sq.m @ £1,750/sq.m
=£94,500
• Zone B = 9 x 6 = 54 sq.m @ £875/sq.m
=£47,250
• Zone C = 9 x 6 = 54 sq.m @ £437.50/sq.m =£23,625
• TOTAL RENTAL VALUE
=£165,375 pa
2
4m
12m
Comparison Method: summary
• Comparison is both a method and a principle
• Comparison method:
– Collect and check evidence
– Select and adjust value factors
– Reconcile comparables and value subject property
• Need a good comparable evidence
• Comparison metrics
–
–
–
–
–
Rent per square metre or zone A rent per square metre
Investment yield
Area ITZA
Capital value
Various YP factors for properties valued as operational entities (or value
per bed, room, seat, etc.)
– Land values