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2.
Topics covered
• The valuation of reversionary commercial real
estate assets
• The term and reversion approach
• The layer (or hardcore or slicing) approach
• Putting the techniques into practice
3.
Reminder: the simple Net Initial Yield
Method
• The textbook format
Rent passing
Years Purchase in
perpetuity @ 3.78%
£130,000
26.4550
Valuation (gross of costs)
£3,493,153
Valuation (net of costs)
£3,250,000
All that is really going on
here is that we are using
deals to find out how many
times the rent, properties are
selling for –in this case
26.455. We’re using that to
value similar properties and
multiplying their rents by
26.455. It’s also the same as
dividing the rent paid by
3.78%
4.
The Valuation of Reversionary
Commercial Real Estate Assets
5.
Valuing Reversionary Properties
• There are other methods for valuing reversionary properties.
• Properties where the tenant is paying less than it’s worth. Where
the Market Rent is higher than the rent paid
• There are two basic approaches to valuing such properties.
– Get the value of the rent paid until rent review
– Get the value of the right to receive the rent after rent review,
– Then add them together
• Or
– Get the value of the right to receive the rent paid forever
– Add the value of the right to get uplift (above the rent paid)
forever.
• For example, let’s value a shop on Oxford Street that has a 10 year
lease with three years until the first rent review. The rent passing is
£100,000 and the Market Rent is £125,000.
7.
Rent
Trying to show that
it’s a perpetuity
Market Rent - £125,000
Rent paid – £100,000
3
Years
Rent review
This is meant to
represent the value
of the right to get
£100,000 for three
years.
This is typically called
the term
The value of the
property is the values
of the term and the
reversion added
together
This is meant to represent the
value of the right to get
£125,000 in perpetuity but it
doesn’t start for three years
This is typically called the
reversion
9.
Rent
Another way of doing this is to split up the rental
incomes differently so…
Market Rent - £125,000
Rent paid – £100,000
3
Years
Rent review
This is meant to
represent the right to
get £100,000 forever.
This is typically called
the bottom slice or
core
The value of the
property is the values
of the core and the
‘top slice’ added
together
This is meant to represent the
right to get £25,000 in
perpetuity but it doesn’t start
for three years
This is typically called the top
slice
11.
Rent
You need four pieces of information to value a
reversionary property – if you’re not using a simple NIY
approach
Market Rent - £125,000
Rent paid – £100,000
3
Rent review
Years
The fourth variable is the yield.
Although I really don’t like to do this we’ll assume the yield for the
moment – we’ll go with 5%.
So now we have the four pieces of information
1. The rent passing - £100,000
2. The Market Rent - £125,000
3. The Term – 3 years
4. The Yield – 5%
12.
The Textbook Layout
Step One – value the term
Rent passing
YP 3 yrs @ 5%
£100,000
2.7232
£272,320
2.7232*£100,000
Step Two – value the reversion
Market Rent
£125,000
YP in perp @ 5%
20
PV 3 yrs @ 5%
0.8638
£2,159,594
Valuation (gross of costs)
Market Value
£2,431,914
£2,298,595
£125,000*20*0.8638
£273,320 + £2,159,914
£2,431,914/1.058
13.
Let’s value it using the slicing or layer or hardcore method – (jarg…)
Step One – value the core
Rent passing
YP in perp @ 5%
It’s the same value as before.
£100,000
20
£2,000,000
Using a food metaphor, we’ve just
sliced up the pizza differently. The
pizza doesn’t change in size.
We’ve applied 5% to the same rents
in both valuations.
Step Two – value the top slice
Market Rent
£25,000
YP in perp @ 5%
20
PV 3 yrs @ 5%
0.8638
£431,900
Valuation (gross of costs)
Also remember that all rents are in
current terms. Expectations about
rental growth are implied in the
yield.
£2,431,900
Slight rounding difference
Market Value
£2,298,582
14.
Rent
Just to be clear….
Market Rent - £125,000
£431,900
Rent paid – £100,000
£2,000,000
Years
3
Rent review
The top slice
This is the value of
the core
15.
For the term and reversion…
Rent
Market Rent - £125,000
Rent paid – £100,000
£272,320
£2,159,594
Years
3
Rent review
This is the value of the term
This the value of the reversion
So, where does the 5% come
from?
16.
Yields come from deals.
Yields come from comparables
Let’s say that a similar shop nearby recently sold for £3,653,000. It was let to Gap two years and three
months ago on a 15 year lease with upwardly only rent reviews every five years at a rent of £146,100 per
annum. The Market Rent is now estimated to be £200,000 per annum.
Well, we basically need to work out the single yield (termed the equivalent yield) applied to both the term
and the reversion (or the top and bottom slice) that produces a value of £3,653,000. Like the IRR, you have
to use iteration (trial and error). The answer is 5% (equivalent yield analysis is for another presentation)
Rent passing
YP 2.75 yrs @
£146,100
5%
2.5112
Value of term
£366,890
Market Rent
£200,000
YP in perp @
5%
20.0000
PV 2.75 yrs @
5%
0.87444
Value of reversion
£3,497,755
Valuation (gross of
costs)
£3,864,645
Market Value
£3,652,784
Key Point: This deal has
informed valuers that a
similar asset has sold at
price that reflects a 5%
equivalent yield
applied to both the
term and the reversion.
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