The document discusses commercial property valuation methods. It defines key terms like market value, price, and worth. It also outlines the five main methods used in commercial property valuation: the investment method, residual method, comparison method, contractors method, and profits method. Each method is described in terms of its methodology, applications, and limitations. The role of valuers is to estimate market price, while calculations of worth are used to analyze pricing and identify potential over/undervaluation.

1. Areas covered
• Role of valuations and valuer
• Definitions of market value, price and worth
• Five methods of commercial property
valuation
– Applications
– Methodology
– Approach

2. Week 1
• Definitions, concepts and bases

3. Rationale
• What are valuations or appraisals?
• Why is there a demand for valuations?
• Why is there a (growing) demand for analysis
of worth or Investment Value?

4. Definitions
• Price - exchange value
• Value – exchange or use value
• Worth
– Individual
– Market
• Valuation - prediction of exchange price

5. Market Value
“The estimated amount for which a property should
exchange on the date of the valuation between a willing
buyer and a willing seller in an arm’s-length transaction
after property marketing wherein the parties has each
acted knowledgeably, prudently and without
compulsion”

6. Role of valuations
• Financial reporting and legal/statutory
requirements
• Lending
• Transaction related
• Performance measurement
• Insurance

7. Global definition of Investment Value
• The value of the property to a particular
investor, or class of investors, for identified
investment objectives.

8. Role of Investment Value calculations
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Buy/sell/hold decisions
Identifying over or underpricing
Choosing between competing assets
‘Customising’ investment analysis to specific
circumstances of the investor

9. Key Points
• Distinction between price and worth
• Valuers’ role has been concerned with price.
• Increasing demand for analysis of prices and
calculations of worth
• Market worth - based upon the assumption
that there is mis-pricing in the commercial
property market

10. The Five Methods of Valuation
• Applications - when are they used?
• Methodologies - how are they used?
• Limitations - what are the problems with using
them?
• NB - read recommended texts in conjunction
with the notes
• Will be further developed in Year 2

11. The five methods
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The investment or income method
The residual method
The comparison method
The contractors or cost method
The profits or accounts method
NB - they are not mutually exclusive

12. Comparison Approach
• Used for the rental valuation of many types of
commercial properties (in UK).
• Used for the valuation of residential property
(in UK).
• Often used as a ‘check’ on other methods.
• Globally - is most widely used for all types of
property.
• Arguably most valuation methods have strong
elements of comparison.

13. Methodology
• Market transactions (deals) provide evidence
of prevailing values.
• This evidence is then applied to the subject
property.
• Appropriate adjustments are made where
required.
• What does heterogeneity imply?

14. Limitations
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Data
Availability
Confidentiality
Quality
Timing
Retrospective
Overvaluation/underval
uation
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Relevance
Heterogeneity
Adjustment
Subjective
Inconsistency
‘Rules of thumb’

15. Residual approach
• Land - with development potential
• Buildings with redevelopment potential
• Incorporated into methods which require a
land valuation

16. Methodology
• Calculate value of development
• Calculate cost of development - including
profit as a cost
• Difference is the remainder that is available
for the purchase of land.

17. Limitations
• There is substantial uncertainty about the
level of costs and revenues
• Techniques commonly used have some
technical weaknesses
• However, these technical weaknesses may not
matter. Why?

18. Investment method
• Derived from mainstream finance.
• Focus on the income.
• Value of an asset reflects the present value of
future income flows.
• Used for commercial properties which
generate a rental income.
• Most important method.

19. Methodology
• A number of variants.
• Basic approach - apply a capitalisation rate to
income stream
• Rents are set in the lease or obtained from
market evidence
• Yields or capitalisation rates are obtained
from sales
• We’ll see that the cap rate or yield is really a
multiplier.

20. Limitations
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Similar to comparison approach
Relies on market evidence
Retrospective
Uniqueness
Availability

21. Contractors method
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No market
Specialist purpose built
Operational purposes
Unusual - one off
Insurance
US - a mainstream
method
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Examples
Oil refinery
Church
Library
Sports Centre
Fire station
Hospital

22. Methodology
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Cost of rebuilding plus
Cost of land minus
Depreciation equals
Existing use value
See Red Book definition

23. Limitations
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Inputs are difficult to calculate
Apart from costs data
Land value?
Depreciation?

24. Profits Method
• Business and property are closely linked
• Hotels/PFS/Restaurants/Cinemas/Pubs
• Income payable is a function of the
profitability of the occupying business.
• Income is capitalised to give a capital value.

25. Methodology
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Rent = Gross Profit - (Net Profit + Tenant Allowance)
Gross Profit = Gross earnings less purchases
Net profit = Gross profit less operating expenses
Tenant Allowance = Tenant’s salary, interest on
tenants investment and risk allowance
• Capital value = Rent/ capitalisation rate

26. Limitations
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Retrospective - historic accounts.
May be misleading or inaccurate.
Trading performance issue.
Subjective.
Controversial.
Alternative approaches increasingly used

27. Key Points
• There is an important distinction between
price and worth
• A valuation is an attempt to estimate market
price
• A calculation of worth can be used to analyse
this price
• There are five methods of estimating price or
market value