Property Valuation

Peter Wyatt

• Publisher: Wiley-Blackwell
• Year: 2013
• ISBN:
  9781118624685
• Edition: 2
• Topic: Business
• Subtopic: Real Estate
• Index: Business

This new edition of the 'all in one' textbook for the postgraduate study of valuation on real estate courses retains its focus on the valuation and appraisal of commercial and industrial property across investment, development and occupier markets. It is structured from the client perspective and covers single-asset pricing, risk and return issues.

The structure of the book has been substantially revised. Part A introduces the key microeconomic principles, focussing on land as a resource, production functions, supply and demand and price determination. The locational aspect of real estate is also introduced. Macroeconomic considerations are categorised by the main market sectors (and their function); the market for land (development), for space (occupation) and for money (investment). The economic context is set and the author then explains why property valuations are required and discusses the main determinants of value and how they might be identified.The mathematics required to financially quantify value determinants are also introduced.Part B of the book describes the methods of valuation; Part C applies these methods to the valuation of a range of property types for a wide variety of purposes; and Part D covers investment and development appraisal.

The author introduces valuation activities from a broad economic perspective, setting valuation in its business finance context and combining its academic and practical roots. Changes in this second edition include:

• less daunting economics
• expanded companion website with PowerPoint slides for lecturers, self-test Questions & Answers for students: see www.wiley.com/go/wyattpropertyvaluation
• up-to-date case studies and sample valuations
• reference to the newly-published Red Book (the valuer's bible)

Property Valuation with its user-friendly format, using tried-and-tested teaching and learning devices and a clear writing style, remains the core text for students on real estate, estate management and land economy degree courses, as well as for fast-track conversion courses for non-cognate graduates.

Part C

Valuation Applications

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Chapter 11 Lease Pricing

Chapter 12 Valuations for Financial Statements and for Secured Lending Purposes

Chapter 13 Valuations for Taxation Purposes

Chapter 14 Valuations for Compulsory Purchase and Compensation

Chapter 15 Specialist Valuations

Chapter 16 Investment Valuations – Further Considerations

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Not all businesses are able, or indeed want, to purchase the property that they intend to occupy. Many of those businesses that do own the properties that they occupy will have financed the acquisitions by borrowing money, perhaps secured against the value of the properties themselves. Many businesses prefer to rent their properties from owner-investors. Doing so means that the occupier does not have to finance its acquisition and the firm has greater flexibility to move when the property is no longer suitable / has become obsolete. The ownership of property, where occupation is transferred to a tenant, is a form of investment, the financial return from which must be sufficient to compensate for the effort of owning the property and leasing it out. Consequently, valuations for investors and valuations for occupiers are two sides of the same coin.

The split between occupation and ownership is personified by the landlord / tenant relationship where, in general terms, the landlord owns a freehold interest in a property and the tenant owns a leasehold interest in the same property. The legal relationship can be more complicated than this with head-leaseholds, ­sub-tenants, overriding leases for example, which can lead to situations where legal advice may be needed to identify the various interests in a single building before any valuation can be tackled. Valuations are required by the owners and occupiers within this landlord / tenant relationship to determine the level of rent that should be paid (the rental value) at the commencement of a new lease, at rent reviews during a lease, at the renewal of an existing lease, and to determine the amount of any compensation payments that might be payable to the tenant by the landlord at the end of the lease end or at its renewal. Moreover, occupiers – whether tenants or owner-occupiers – may require capital valuations of their property assets for inclusion in company financial statements. If a business ­operator wishes to purchase a property it may well do so using debt finance and the lender will require a capital valuation of the property if it is going to be used as collateral for the loan. These are probably the most common reasons for ­valuers being asked to conduct rental and capital valuations of commercial property from an occupation perspective but there are other reasons too: rental and capital ­valuations of properties are required by Government for tax purposes; capital valuations are required when business property is to be compulsorily acquired or when compensation payments are due; and insurance companies require capital valuations of business premises that they insure. This part of the book will look at each of these.

Chapter 11

Lease Pricing

11.1 Introduction

This chapter is concerned with the assessment of rental value at the commencement of a new lease, at a rent review or at the point when an existing lease is renewed. Usually this is a matter of gathering and adjusting comparable evidence from recent lettings of similar properties in the locality using the comparison method of valuation. However, the increasing diversity of lease contracts means that this process is no longer as straightforward as it sounds: as French et al. (2000) put it:

In the late 1990s the business environment experienced substantial structural change and tenants began to demand bespoke leases to suit their particular occupational requirements. This led to a plethora of different lease contracts, as tenants require shorter leases, the ability to expand and contract, break clauses and upwards/downwards rent reviews. The market is now as diverse as it was uniform.

This structural change in the business environment was caused initially by an over-supply of commercial property (office space in London in particular), but then there was a shift in the organisational structure of businesses in all sectors. In the office sector changing working practices brought about by increased use of IT such as hot-desking, home-working and peripatetic office use, outsourcing not only of non-core or peripheral business but also management of property and estates, increased use of serviced offices and other ways of using accommodation over short time periods. All of this has had a profound effect on the conventional lease contract and has shortened the economic life of many commercial buildings due to the early onset of obsolescence. Many of these buildings are otherwise physically sound and have found new uses, such as residential apartments. In the retail sector, internet shopping, home delivery and the perception of shopping as leisure activity has changed occupier requirements. In the industrial (factories and warehouses) sector these retail trends have led to an increased demand for large shed-style warehousing facilities and, in cases where manufacturing does take place in the UK, the automation of production has meant that factory requirements can be highly specified. The growth of data centres within a 25 mile radius of London has been rapid and these are often located on industrial parks.

Up until the end of the 1980s standard leases in the UK were 20–25 years long with all repair and insurance liabilities imposed on the tenant, either directly or via a service charge in a multi-let property. Most leases provided for upward-only rent reviews every five years. Tenants had the right to renew their leases under the Landlord and Tenant Act 1954 and could usually assign or sub-let any unexpired lease term with the landlord’s consent, which could not be unreasonably withheld. Until 1996 tenants had a continuing liability for lease terms after assignment. In 1996 this liability was removed but, as a partial compromise, landlords were given greater scope for refusing to allow an assignment. Where assignment is permitted, the landlord can require the outgoing tenant to guarantee the lease obligations of the incoming tenant (Crosby et al., 1998). Much of this conventional lease structure remains intact but there has been a significant reduction in average lease length and the number of leases with break options has increased substantially. Tenants now want a choice of flexible lease contracts that allow them to respond quickly to changing business circumstances. The BPF / IPD Annual Lease Review (2011) reveals a reduction in a verage lease length across all commercial real estate from 8.7 years in 1999 to 5.3 years in 2010. By sector, the average lease length for office space was 4.7 years, for retail it was 5.7 years and for industrial it was 4.2 years. Around a third of all leases contain a break clause.

11.2 Lease incentives

Landlords sometimes offer incentives to tenants and in the sections that follow the financial impact on rental value of typical incentives are considered. In each case the valuer is trying to estimate the effective rent that is being paid and this comprises the headline rent less the annual equivalent value of any incentives offered by the landlord plus the annual equivalent of any capital expenditure for the acquisition of the interest and expenditure on alterations or improvements by the tenant. It is important to remember that cost does not always equate to value and therefore not all expenditure need be amortised – each item must be considered carefully. Rents agr...