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  • 1. COMMERCIAL PROPERTY VALUATION IN THE UK
  • 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.
  • 6. The term and reversion approach
  • 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
  • 8. The layer (or hardcore or slicing) approach
  • 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
  • 10. Putting the techniques into practice
  • 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.