COMMERCIAL PROPERTY VALUATION
USING CAP RATE (YIELDS)
• Rationale, role of valuations and required
competencies for valuation
• The simple Net Initial Yield approach to
commercial property valuation
1. Rationale, role of valuations and
required competencies for valuation
To estimate Market Value for
–Doing deals (setting asking prices, working
out what the ’going rate’ is for a property)
–Measuring investment performance
(capital, income and total returns)
–Borrowing against the properties (banks
always want to know the value of the collateral)
–Financial reporting (balance
sheet, company accounts)
It is about
Capitalising (transforming into a capital value)
• Let’s say that you wanted to put a value on
the right to get £100 every year for the next
four years. You want to capitalise (i.e put a
capital value on) this income stream. The
capitalisation rate is 10%.
You could value the right to get £100 for four
years using a cash flow. This is a fixed income
for a fixed period.
As a formula this is: £100*1+0.1-1 + £100*1+0.1-2 +£100*1+0.1-3 +£100*1+0.1-4
Via geometric summation, this can be
(1 (1.1 4 )
Capitalising Perpetual Fixed Income Streams
• Let’s say that you have to put a value on the right
to get £100 per annum forever (i.e. in perpetuity)
• If you look at the previous equation…. and the
(1+i)-n part in the top right.
• The larger ‘n’, the smaller this part of the
• When it is infinity , then this part of the equation
Fixed perpetual incomes are really simple
This becomes zero and
we are left with…
Which is the same as
So in order to get the capital value the right to receive the right to
receive £100 per annum forever, it’s basically £100 times 1 divided
by the capitalisation rate or just £100 divided by the capitalisation
The Simple Net Initial Yield
Approach to Commercial Property
The Simple Net Initial Yield Approach
• Ignoring transaction costs, you need to obtain and
process two pieces of information to get the value of a
commercial property when using the NIY approach
• The current rent paid
• The Net Initial Yield (this is a capitalisation rate)
• The first is a fact. It is the contractually agreed rent.
• The second is an estimate. The estimate is based upon
analysing deals involving comparable properties
• You have been instructed to estimate the Market
Value of a shop on Oxford Street let three years
ago to Samsung on a 15 year lease with upwardly
only rent reviews every five years at a
£130,000 per annum.
Rent is now £175,000 per annum.
• What is the only relevant (to an NIY valuation)
piece of information here?
• A similar shop nearby recently sold for
It was let to The 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
• What are the two relevant facts here?
Analysing the Comparable
• Net Initial Yield is an expression of the relationship
between the amount invested and the rental income.
• The total amount invested is price paid plus buying costs
such as Stamp Duty (4% of price paid for commercial
properties over £500,000), agents’ commission, legal
fees , surveys, VAT on above. They work out (as I write)
at about 5.8% of price paid in total – in the UK.
• The total invested in the comparable was?
• …and the Net Initial Yield was
• £146,100 divided by £3,864,645 – 3.78%
• Going back to the subject pproperty…So £130,000
divided by 3.78% is £3,439,153.
• This is the valuation before deduction of acquisition
• The easiest way to get to the Market Value is just to
divide £3.439 million by 1.058.
• That just over £3.25 million
• All you need to remember is that when working out
yields, it is normal to add on costs to the price paid.
When doing a valuation in the UK, it is standard to
take off transaction costs. You do that by dividing
the valuation gross of transaction costs by
You can value any income producing
property like that
• A UK textbook would have something like…
Years Purchase in
perpetuity @ 3.78%
Valuation (gross of
Valuation (net of
Expectations about rental growth are included in the cap rate/yield:
let’s say that we want to put a value on the right to get £100 for the next ten years (I
can’t show forever) but it is expected to grow at 3% a year and we have a target rate
of return of 10%
This can be obtained by
The obvious thing to do is to grow the income in a cash flow and discount at 10% i.e. change the cash flow
to reflect growth.
Income PV factor @ 10%
A less obvious
thing to do is
to change the
Income PV factor @ 6.7961%
So we value a growing income in two ways – by changing the cash
flow or by changing the discount rate. Of course, you don’t need
to do a cash flow if it is in the discount rate, you just use.
If it was £100 growing at 3% p.a. forever, rather
than 10 years, it is just £100/0.067961 = £1471.43